Why ecommerce will morph into local commerce in India

It is no secret that e-retail in India has been growing at a dramatic pace. It is expected to reach $22 billion in three years (from a negligible size five years back) after attracting billions of dollars in venture investment. Several unicorns have been created in this space. More than 40 million users already shop online in the country, and this number is expected to rise rapidly towards the 100 million mark.

The classic ecommerce model entails a small number of large efficient warehouses built across the country, coupled with a well-oiled logistics network that can deliver merchandise to consumers anywhere within a few days. However, this model has three basic constraints that will lead to its evolution:

First, the big centralised warehouse ecommerce model is economically sub-optimal in India. Shipping one package across the country and into smaller towns costs significantly more on a unit basis than 'caching' goods closer to where the demand is. This issue is more pronounced in India than it is in many other markets "the ASPs in India are typically low, while the logistics (shipping, warehousing) costs are not proportionately low. For example, for a generic retailer, the Average Order Value in India may be Rs 1,000 ($16) vs $50 in the US (i.e. a third) for a retailer with a similar category mix, but the unit logistics cost at scale may only be 40 per cent lower in India. Return shipping and logistics increases unit costs further. The marketplace model with platform fulfillment could add in yet another leg of shipping. Shipping and logistics can cost 8-10 per cent of the gross merchandise value for many e-retailers and marketplaces, and this cost item appropriates much of the gross margin/platform fee for several e-retail categories. In fact, classic ecommerce may not have the structural cost advantage over brick and mortar retailers that it has enjoyed in many other markets. Charging separately for delivery on a widespread basis will always be hard in a highly competitive market like India. In order to drive towards profitability and better unit economics, ecommerce companies will need to find disruptive ways to optimise their shipping and logistics expenses.

Second, as the consumer gets used to instant on-demand services such as food delivery and taxi services, waiting say three days to receive the USB drive he/she ordered from a distant seller will become increasingly unacceptable even to consumers in smaller towns. With the traditional ecommerce model, delivery to various parts of the country could take several days on average. This is further impacted by additional areas of friction such as inter-state taxes and state border check-posts. Many large ecommerce companies are already racing to build next day and same day (in larger cities) delivery, often via a combination of local warehouses in larger cities and overnight air shipping. Instant gratification is a key advantage of local purchase at offline retail stores, which needs to be countered or offset by ecommerce platforms. Thus the natural pressure is for ecommerce to move towards more instant models, such that consumers can receive goods they ordered within a few hours or less. Amazon, JD and others are looking to achieve this by building a chain of metro area warehouses across their respective geographies of focus. Leading Indian marketplaces have also set off on this path. However, this model is highly capital intensive, and by itself, may not be ideal in the Indian context where unit real estate/rental costs are high. Additionally, while it may work for some categories such as consumer electronics, it could be cost prohibitive for other categories such as appliances, furniture or home goods. Further, this approach does not work as well with the marketplace model which is predominant in India.

Third, the ecommerce model doesn't lend itself to instant returns and exchanges. For example, consumers do not have the option of taking a defective product back to a nearby store and exchanging it immediately for a functioning one. For many consumers, this is a significant mental barrier to ordering some categories of goods online, and a big psychological advantage of shopping locally.

Now, as we know, most large ecommerce platforms in India function as marketplaces with tens or hundreds of thousands of merchants. Many of these merchants are local shopkeepers who have begun to sell online via these platforms. These merchants already stock the goods at their own premises in local neighborhoods.

Evolution to local commerce

Several of the above constraints could be addressed by marketplaces with sufficient density of local merchants such that a reasonable volume of transactions is fulfilled locally. This would bring down unit shipping costs, provide significantly faster delivery and provide consumers the comfort to return/exchange merchandise more expeditiously when needed.

This model makes imminent sense for categories where local availability of merchandise is high, and the logistics cost form a relatively high proportion of net revenue—for example, appliances & furniture (where shipping long distance is cost prohibitive and time consuming), food and groceries (which constitute over 60 per cent of overall retail sales in India), home goods and books. We are already starting to see various leading horizontal marketplaces launch the grocery category via a local fulfillment model—Amazon's recently soft-launched Kirana Now service, which aims to deliver groceries locally within 2-4 hours via tie-ups with local stores.

This local commerce and fulfillment model will expand to several other major e-retailing categories beyond groceries. The LCD television, microwave, book or even smartphone could be conveniently delivered in an hour from the nearby electronics or book store rather than making its way across the country via various modes of transport.

The eventual optimal model may be a hybrid one with a reasonable bulk of demand being fulfilled locally via neighborhood merchants or fulfillment centers, and only long tail products (or those more readily available in other regions) being shipped individually to the customer from a centralised warehouse. As ecommerce/marketplace platforms push ahead in their quest for profitability and compete on faster delivery times, they will push harder into local commerce, and converge with various other startups already building out the local delivery model. We expect to see tremendous innovation in this space.

(Anupam Rastogi is a VC investing in mobile, internet & technology businesses in India and the US. Anupam has been involved in investing in India since 2007, and currently spearheads regional investments in India and global investments in the Local Marketplaces/Commerce space at Nokia Growth Partners. Data and facts cited are based on public sources. Views are personal.)