by A similar story might play out in the Zomato IPO case, and this is precisely the reason why I am not going to invest in Zomato IPO. Hi, everyone Welcome to today’s article So today we are going to discuss the Zomato business model. Now we are going to see that in the context of the IPO that Zomato is going to launch. And finally, I’m going to present my analysis of why or why not I’m investing in Zomato IPO. With that said, let’s get this article started.
I’ve structured this article into five parts: number one, I’m going to help you understand Zomato’s business model. What is it that Zomato does and what series of steps it has followed to get to a five-billion-dollar valuation? Number two, I’m going to help you understand Zomato’s unit economics. So, unit economics means that if Zomato delivers one order, is it making money or is it losing money? Number three, I’m going to help you understand whether or not this unit economy is going to sustain a company like Zomato.
Fourth, I am going to help you understand investors’ perspectives that what is the game plan that investors have in mind while launching Zomato IPO and taking it to the public market?
Finally, I’m going to present my analysis of whether or not I’m going to invest in Zomato IPO.
Zomato’s Business Model
So, let’s begin by understanding Zomato’s business model, and we can divide this into a series of successive steps.
The first step involves identifying a major pain point in the business ecosystem. So Zomato as we know, it’s a food delivery app and it connects customers, people like us who want to order food with restaurants, who want to sell food. So Zomato plays the twin role that connects customers like us who are looking to order food, it makes the process convenient for them. Just with a click of an app, you can order food.
On, the flip side, it helps a lot of restaurants get discovered. For example, if I’m starting a new restaurant and if I want to start making sales right from day one, I can’t usually do it. But if I have a tie-up in Zomato or Swiggy, and if I’m discoverable on their app, it might become very easy for me to start selling my product.
So, to cut the long story short, Zomato was able to identify a beautiful main point in the ecosystem of food delivery, where it offered convenience to customers like us. And, on the other side, it offered discoverability to new restaurants that we’re able to sell more of their product.
Given this strong business model and strong promise of solving an actual pain point, Zomato was able to scale new heights every single year, and its valuation kept going up and up and up. So, this gets us to step two, which is a customer acquisition game that Zomato has to unfortunately play.
As Zomato started to grow, it attracted more investors. As investors poured in more money, they wanted to see growth, and Zomato had no option but to acquire customers left, right, and center.
Now, I’m not talking about acquiring customers in hundreds of thousands or hundred thousand, but in millions. So, therefore, all the marketing that you see on Twitter, Facebook, Instagram that Zomato actively does, it’s mostly to promote its customer acquisition game.
So, acquiring a large number of customers became customary for a company like Zomato to keep on growing and getting new rounds of investment. This brings us to step three, that once Zomato has acquired enough customers, they need to make their business venture profitable.
How do they make the business profitable?
Now, how do they make the business profitable? By making sure that customers get into the habit of ordering food via the Zomato app. Now, essentially, just to talk about the business sense here:
To acquire any customer, for example, if Zomato IPO wants to acquire a customer like me, they will have to send me notifications.
They will have to write me emails. They will have to market a lot of material to me. And eventually, then I will sign up for the Zomato app. This is called Customer Acquisition Cost, and this is usually around 200-250 for a company like Zomato to acquire a new customer.
Now for every order, let’s assume that Zomato makes 20 rupees. Then it needs to ensure that I got into the habit of ordering food from them and I at least order 10 to 15 times to justify that customer acquisition cost.
Involves getting me into a habit of using the Zomato app to order food. Now, companies like Zomato are very smart and this brings us to step four that they analyze a lot of data. They show you curated images, they show you a bunch of notifications. So that’s one way of manipulating your psychology to order more food. That’s one. Number two, they use tempting pictures. They will keep showing you pictures of delicious food and you will be compelled to order. That is just one part of the equation.
Involves a company like Zomato introducing something called a switching cost. So you might have seen that Zomato has something called Zomato pro or Zomato gold. Now, essentially, that membership, if you have bought such a membership, then you are somewhat tied to that app.
So every time you would go on and you would have to decide between picking Swiggy or picking Zomato for ordering food, you will check that, & quote; hey, I have Zomato gold, so I’ll go and order food from Zomato because I’m getting some additional discounts or additional perks in terms of delivery.& quote; These incentives act as a hook, that does not allow you to switch from one app to the next.
Once a customer is hooked and he or she has built a habit, they will keep on ordering food more and more and Zomato will keep on becoming more profitable. This gets us to step five where ensuring profitability and expanding profitability becomes the name of the game. Now, to ensure this profitability, there are a bunch of measures that a company like Zomato takes.
For example, number one, they would push their customers to order food more frequently. Number two, they can also incorporate things like decreasing the money that they pay out to delivery people, or they might charge higher commissions from restaurants, or they might cut down on a lot of costs like packaging and a bunch of other measures that they can incorporate.
So this is where investments that investors have made previously start kicking in and start profiting a company like Zomato. Now, just to very quickly conclude that companies like Zomato identify major pain points in the business ecosystem, they fill that gap with the promise of their business model. They bring on investors which gives them enough money to play the customer acquisition game.
And finally, they get customers hooked to a habit who keep on using the app, ordering more and more food that makes the company profitable. So it looks very simple and this is how the business model works.
Understanding the unit economics of a food delivery company
Now, this gets us to step two, which is understanding the unit economics of a food delivery company. Now, let me spend some time here helping you understand what the unit economic means and why is it such an important metric for a food delivery company like Zomato or Swiggy.
What the unit economic mean?
Unit economics essentially means that if one packet of food is getting delivered to your home, how much money did Zomato spend in terms of ensuring that, and how much profit is it making out of it. Now up until last year, Zomato was losing a lot of money in terms of this unit economics and suddenly when it decided to file for IPO, this unit economics has become positive.
I’ll flash a graph in front of you. Now, this comes directly from the Zomato report, which is a red herring prospectus from Zomato’s material and you can see this change. Now, if we compare the financial data for 2020 and compare the unit economics there with 2021, you will see that last year in 2020, Zomato was losing 30.5 rupees with every single order. Now, this has dramatically changed and it has become 22.9 rupee profit per order. So this has been a magnificent jump. Now we need to take a look at the ingredients of how this has happened So very quickly, going into the graphs here.
If you see the red bars, now essentially commissions and other charges or customer delivery charges, these are positive things. These are revenues that Zomato is making, for example, it charges commissions to the restaurant when it helps them get an order to a customer. Similarly, as a customer, you would often pay customer delivery charges. So these are things that add to the revenues for Zomato.
On the flip side, we have costs, for example, for every order that Zomatoensures it has to pay a delivery cost to its delivery partners. It has to run some discounts. It has other variable costs in the mix. So which if you subtract revenues minus cost, you get the eventual result. Now, it’s very interesting to go into the specifics of things.
I would want you to notice three specific things here. So the first thing that I would want you to notice is the commissions and other charges tab. Now, let’s try to understand this from an example.
Let’s say that you are very fond of having pizza from Pizza Hut and you order pizza and Zomato delivers it. Then what would happen here is that if you take a look at the commissions and other charges tab from the fiscal year 2020, you will see that commissions have increased from 43.6 rupees to 62.8 rupees this year.
Now, just to plug this into our example, so last year Pizza Hut was paying Zomato,43.6rupees for one order value. And this year it has been 62.8 rupees for that same order value. The problem here is that if more and more restaurants are being charged higher commissions, then they will get super pissed with this equation. So this is the first thing that I want you to notice.
Second, I would want you to take a look at the customer delivery charge. Now, this is a charge that you and I pay. Last year it was 15.3 rupees per order, and now it has gone up to 26.8 rupees. Now you tell me if the delivery charges keep going up and up and up, then when you order more food or less food going forward, I bet that you would order less food.
Additionally, I would also want you to take a look at the discount stamp. Now discount is the cost that Zomato incurs. So last year it was incurring 21.7 rupees and this year its only incurring 7.3 rupees, which means that on average Zomato has decreased its discount. Now, again, in a country like India, discounting is a very big driver, especially for food items.
If we get discounts, we order more. If you don’t get discounts and we do not order. That’s a simple equation that we follow. So, again, going forward to a customer, they have pissed off the customers.
If you take a look at the restaurants, they are pissing off the restaurants. And finally, I would want you to take a look at the third tab, which is the delivery cost. Now, this is the number of money that usually goes to paying the delivery partner or the person who comes and delivers it on their bike.
So last year, Zomato used to pay approximately 52 rupees to that delivery partner, and now it’s paying 44.6. Now, if you look at the numbers and try to understand the story behind these numbers, the story is very simple, that the customers are getting pissed off because the discounts are going low and the delivery fees are getting higher and higher.
Number two, the restaurants will get pissed off because they are being charged higher commissions. And finally, the delivery partners will get pissed off because they are getting lower and lower amounts to deliver every order.
This is a recipe for disaster, and it might not be a very easy thing to execute in a sustainable manner going forward. This brings us to part three of the story where we will ask the simple question.
Is this unit economics sustainable?
In my opinion, the answer is no. I don’t think that this business model or this unit economics model is sustainable. And there are three reasons why I say that. The number one reason is that food is not a commodity good.
Zomato’s model vs Uber’s model
For example, if you compare Zomato’s model to Uber’s model, it’s somewhat similar in system and technology. In Uber what does happen, that it connects drivers with people who are looking for a ride? Now in Uber, you will not worry about whether you are getting a Maruti Zen or whether you’re getting an Alto as a car.
It would hardly matter to you because you are just interested in going from one destination A to destination B.So that’s somewhat of a commodity good. But if you compare it to a food delivery business like Zomato, is food a commodity good? My answer is probably no, because if you have your favorite pizza place and if it leaves Zomato, then would you still order food from Zomato? My bet is no.
You would be more interested in buying that food from that particular restaurant because you love eating from that restaurant. Zomato just becomes a carrier for you to pick up that order from that restaurant and bringing it to you.
In my opinion, Zomato will not be able to do something that Uber was able to do. For example, Uber used to screw up drivers on their commission. When they were able to scale their business, they used to cut down the commissions of the driver. But I as a customer did not get impacted because my goal was to go from point A to point B so I could not care less about the business model of Uber.
On the flip side, however, I would care a lot whether my favorite restaurant is still working with Zomato or not. So from that angle, Zomato might see a lot of customers losing out and switching to different apps like Swiggyor switching to cloud kitchens so that is one.
The second is that if you look at the competitive landscape, it also makes the unit economics of Zomato not sustainable. For example, if you take a look at Swiggy’sbusiness model when Swiggy was a two million dollar company, Zomato was a one-billion-dollar company, it was already a unicorn. Now both Swiggy and Zomato are competing for heads on and both are valued at around five billion dollars in the current landscape.
The bottom line is that till the time investors are pouring more and more money, both these companies can keep burning cash till the time one company gets acquired by the other. And at that stage, because people are hooked to ordering food online, that is where the actual profit-making might start.
The third and final reason why I feel that Zomato’s unit economics model might not be sustainable because of new technologies. Now it’s very easy for restaurants to develop their website. There are very easy plug-in-play websites.
It’s very easy to integrate payment systems. So you might have already started seeing that when you order food from your favorite restaurant from Zomato, they give you their brochure and they tell you that " hey, order from us directly and we will give you a 20 percent discount because it’s very easy for these restaurants also to build such technology-oriented systems.
So they would not want to pay commissions to companies like Zomato or Swiggy. So do give your comments if your favorite restaurant also sends you brochures in terms of ordering food from them, would love to read more stories there. But for the time being on this case study, let’s move on to part number four, which is understanding investors’ perspectives.
Understanding investors’ perspectives
The point is that investors are super smart, they already understand what is happening in the market. So there are essentially three ways in which investors can make money from a company.
The number one option is that the company in which an investor has made investments that super-profitable and the company pays the investor back. This is super easy, but this is not happening in Zomato’s case, as of now.
The number two option for investors to makes money is that the investor helps Zomato grow to a massive scale and post that the investor sells its equity to someone else, that is they bring on a new investor. Now, this is a very difficult thing to accomplish in a mature company or a mature startup-like Zomato. So it’s highly unlikely that Zomatoinvestors might be able to find an exit by finding new investors in the company.
the third option for investors to takes their investment, in this case, Zomato to the IPO, which is to make it a publicly listed company so that retail investors can start investing money in Zomato and investors can get their money back and sell their equity.
What is going to happen with Zomato IPO?
This is what is happening in Zomato’s case, which brings us to the fifth part of this case study that what is going to happen with Zomato IPO? Now, before giving my verdict on Zomato, I would like to show you a sample case, which is of a company called MRS Bectors Food whose IPO was also very recently launched, and it operates in a similar space, similar food, and beverages space.
So if you look at the company, it’s a profit-making company and it made 40 crores of profit in the last quarter. If you take a look at how the IPO went for this particular company, that will give you a lot of insight into what might happen with Zomato IPO also. So let’s look at the chart for MRS Bectors Food.
So MRS Bectors’ stock was made available on 24th December 2020, which is approximately six months ago, and it opened at 594.20 rupees, approximately 600 rupees. And today it is trading at 402 rupees. There has been a massive drop, approximately a 33 percent loss. The worst part is not that the retail investors lost money. The worst part is that the share price opened at approximately six hundred rupees and it kept going down.
A lot of retail investors who do not understand the stock market properly kept on holding the stock and they are still holding the stock when it has fallen by 33 percent. So a similar story might play out in Zomato’s case. And this is precisely the reason why I am not going to invest in Zomato IPO.
I’m not saying that people might not make money in the IPO listing of Zomato, but in my humble opinion, I do not see the fundamentals in such a way that I can consider it to be a massive profit-making company. I genuinely feel that investors are just looking for a way out and IPO gives them a perfect exit.
Conclusion
I hope you found this insight to be useful and meaningful. One should follow the Risk Management, Money Management, and Fear and Greed concept of the market to avoid big losses. Please comment on what case studies you would want me to make. I would appreciate it. And share it with your friends that will help this website grow. And I will keep making more awesome articles. For more trading ideas do follow us on
