1/ @namanlahoty, @rchowdhri, @rupaligoel9 and myself at @Stellaris_VP recently did a #B2B #commerce refresh in light of 10 years of B2B commerce.
As a part of it, we spoke to several B2B commerce investors and founders, both in India and outside.
Synthesis of our top findings👇
As a part of it, we spoke to several B2B commerce investors and founders, both in India and outside.
Synthesis of our top findings👇
2/ While it's clear the public markets will value these companies as a multiple of EBITDA, the biggest mystery for all is what that multiple would be.
We've heard multiples ranging from 10x to 40x of NTM (next twelve month) EBITDA in our conversations.
We've heard multiples ranging from 10x to 40x of NTM (next twelve month) EBITDA in our conversations.
3/ Though what is clear is that the multiple would largely be a function of 3 factors:
(A) Scalability
(B) Profitability
(C) Defensibility
Let's unpack each.
(A) Scalability
(B) Profitability
(C) Defensibility
Let's unpack each.
4/ Scalability
This has been the primary sell of B2B commerce companies and primary attraction for investors, and I'd say the sector has overall lived up to this promise.
There are examples of at least 4 B2B commerce companies which've crossed $1B in annual GMV in just 7 years.
This has been the primary sell of B2B commerce companies and primary attraction for investors, and I'd say the sector has overall lived up to this promise.
There are examples of at least 4 B2B commerce companies which've crossed $1B in annual GMV in just 7 years.
5/ We however learnt that some B2B commerce companies have scaled faster than others, and there are clear patterns as to why. Key factors include:
(A) Net working capital days
(B) Buyer's credit risk profile
(C) Enterprise vs SMB buyer
(D) Internal process and tech
(A) Net working capital days
(B) Buyer's credit risk profile
(C) Enterprise vs SMB buyer
(D) Internal process and tech
6/ Net working capital days
Ideal is to have this at 30 days or below, even if it comes at the cost of margins.
Working capital scales linearly with GMV. Even with 30 days, ~$80M of working capital is needed at scale of $1B in GMV.
Ideal is to have this at 30 days or below, even if it comes at the cost of margins.
Working capital scales linearly with GMV. Even with 30 days, ~$80M of working capital is needed at scale of $1B in GMV.
More the working capital period, more the equity capital needed, more the dilution for all the shareholders, and more the dependency on external fundraising.
7/ Buyer's credit risk profile
This is the classic lesson from the world of NBFCs and banks. Lower the borrower's credit risk profile, higher is their ability to withstand economic shocks, more stable is the credit book, and consequently higher is the ability to get leverage.
This is the classic lesson from the world of NBFCs and banks. Lower the borrower's credit risk profile, higher is their ability to withstand economic shocks, more stable is the credit book, and consequently higher is the ability to get leverage.
8/ Case in point being MFI's. MFI's see a higher profitability (and RoA) than banks during the regular cycle, however suffer from poor scalability.
This on account of profitability getting wiped out during the stress cycles, and inability to get leverage, which dampens the RoE.
This on account of profitability getting wiped out during the stress cycles, and inability to get leverage, which dampens the RoE.
9/ Thus, B2B commerce companies targeting low-risk enterprise buyers tend to be more scaleable than the ones targeting high-risk SME buyers.
Exception here being SME models operating on cash and carry OR on small credit cycles (<14 days). Eg. Bijnis, GoldSetu.
Exception here being SME models operating on cash and carry OR on small credit cycles (<14 days). Eg. Bijnis, GoldSetu.
10/ Enterprise vs SMB buyer
B2B businesses continue to be people heavy requiring human touch for every transaction, both at buyer's and seller's end. India continues to be Do-it-for-me country as opposed to Do-it-yourself.
B2B businesses continue to be people heavy requiring human touch for every transaction, both at buyer's and seller's end. India continues to be Do-it-for-me country as opposed to Do-it-yourself.
11/ As a result, the direct human cost involved (at a transaction level) is not too different for an enterprise order vs an SME order. However, what is vastly different is the transaction size.
Thus, you need a materially larger human army to build a SME business of same size.
Thus, you need a materially larger human army to build a SME business of same size.
12/ Hence, B2B commerce companies serving enterprise customers tend to be more scalable.
Exception here being SME businesses which are truly Do-it-yourself. These typically target SMEs in tier 3 and beyond which are truly underserved and don't get Do-it-for-me facility.
Exception here being SME businesses which are truly Do-it-yourself. These typically target SMEs in tier 3 and beyond which are truly underserved and don't get Do-it-for-me facility.
13/ Internal process and tech
Scaling through people only takes you so far, beyond which you need robust internal processes and tech. Amongst other things, this is a reason why unorganised incumbents in the supply chain don't scale beyond a point.
Scaling through people only takes you so far, beyond which you need robust internal processes and tech. Amongst other things, this is a reason why unorganised incumbents in the supply chain don't scale beyond a point.
14/ Profitability
Our key learning has been that the north star to gauge profitability is not CM 2, not EBITDA, not RoA, but ROCE (or RoE).
ROCE is the true indicator which encapsulates both margins and working capital period, which go hand in hand for a B2B commerce business.
Our key learning has been that the north star to gauge profitability is not CM 2, not EBITDA, not RoA, but ROCE (or RoE).
ROCE is the true indicator which encapsulates both margins and working capital period, which go hand in hand for a B2B commerce business.
15/ The golden and consistent ROCE number we've heard in our conversations is 30%+.
This ensures that even if no external equity capital is available, business can deploy it's profits to grow 30% YoY. And this is above the IRR threshold that PE /VC investors commit to their LPs.
This ensures that even if no external equity capital is available, business can deploy it's profits to grow 30% YoY. And this is above the IRR threshold that PE /VC investors commit to their LPs.
16/ ROCE in turn is a derivative of 3 key financial metrics i.e.
(A) CM 2 margins (net of all direct costs at a transaction level including interest and bad debt costs)
(B) Net working capital period
(C) Leverage ratio
(A) CM 2 margins (net of all direct costs at a transaction level including interest and bad debt costs)
(B) Net working capital period
(C) Leverage ratio
17/ However, one of the practical issue that surfaced was that for an early stage or idea stage B2B commerce company (where none of the above financial data exists), how does one go about building a view on ROCE.
At @Stellaris, we've built a framework for the same.
At @Stellaris, we've built a framework for the same.
18/ Here it goes:
ROCE (B2B commerce company) = Sum of real-world ROCE (of unorganised incumbents in the supply chain it plans to replace) + 4 Adjustment factors (below)
(A) Organised-player ROCE losses
(B) Efficiency ROCE gains
(C) Leverage ROCE gains
(D) Scale ROCE gains
ROCE (B2B commerce company) = Sum of real-world ROCE (of unorganised incumbents in the supply chain it plans to replace) + 4 Adjustment factors (below)
(A) Organised-player ROCE losses
(B) Efficiency ROCE gains
(C) Leverage ROCE gains
(D) Scale ROCE gains
19/ Organised-player ROCE losses
This will factor in ROCE losses for the B2B commerce company on account of their inability to compete with cost structure practices like tax theft, limited corporate cost, promoter not taking salary, multi-staffing of employees etc.
This will factor in ROCE losses for the B2B commerce company on account of their inability to compete with cost structure practices like tax theft, limited corporate cost, promoter not taking salary, multi-staffing of employees etc.
20/ Efficiency ROCE gains
This will factor in ROCE gains for the B2B commerce company on account of having strong internal process and tech.
An example we heard here high ROCE on back of lower wastage for perishables than the incumbents.
This will factor in ROCE gains for the B2B commerce company on account of having strong internal process and tech.
An example we heard here high ROCE on back of lower wastage for perishables than the incumbents.
21/ Leverage ROCE gains
One of the key reasons why unorganised incumbents don't scale is their inability to get debt (and thus leverage).
B2B commerce companies owing to their scale and equity capital can juice up their ROCE materially by getting leverage. This is a KEY factor.
One of the key reasons why unorganised incumbents don't scale is their inability to get debt (and thus leverage).
B2B commerce companies owing to their scale and equity capital can juice up their ROCE materially by getting leverage. This is a KEY factor.
22/ Scale ROCE gains
These include ROCE gains at scale owing to activities like launching private labels, entering into 2P (second party) manufacturing contracts, increasing mix of exports, M&A of profitable factories etc.
These include ROCE gains at scale owing to activities like launching private labels, entering into 2P (second party) manufacturing contracts, increasing mix of exports, M&A of profitable factories etc.
23/ Defensibility
One of the key reasons why B2B commerce companies have scaled is by taking advantage of the poor defensibility and poor stickiness that the unorganised incumbents had with their buyers and suppliers.
One of the key reasons why B2B commerce companies have scaled is by taking advantage of the poor defensibility and poor stickiness that the unorganised incumbents had with their buyers and suppliers.
24/ However, they risk the same fate. To prevent it, it's important to build what we internally call a "non-commercial" value prop.
Some examples we heard include:
(A) Robust multi-vendor project-management layer to deliver speed
Some examples we heard include:
(A) Robust multi-vendor project-management layer to deliver speed
(B) Solutioning layer to convert complex client order into multiple and simple execution pieces
(C) R&D and compliance layer to deliver adherence
(D) Real-time inventory, capacity and post-order visibility to deliver transparency
(C) R&D and compliance layer to deliver adherence
(D) Real-time inventory, capacity and post-order visibility to deliver transparency
25/ To summarise, while we spoke about the 3 key factors of Scalability, Profitability and Defensibility, what's in our judgement is unproven still is "Profitability" and to some extent "Defensibility".
26/ We heard that all B2B commerce companies (standalone; not including M&A) are sub 3% EBITDA (net of interest and bad debt costs) at present, with a *potential* path to 5% in future.
With the exception of a handful, I believe most B2B companies in India are still at <30% ROCE.
With the exception of a handful, I believe most B2B companies in India are still at <30% ROCE.
Loading suggestions...