Will Amazon, RIL edge out venture capital-backed startups from the e-pharmacy game?

Within a single week, India’s nascent online pharmacy industry has transitioned swiftly from being the preserve of a handful of startups to a high stakes playground for the big boys of the consumer internet sector. 

Last week, Seattle headquartered ecommerce giant Amazon announced its foray into online pharmacy services with a soft launch in Bengaluru. Days after, Mukesh Ambani-led Reliance Industries (RIL) acquired a majority equity stake in Chennai-based Netmeds. Walmart-owned Flipkart, according to media reports, is also preparing to enter the arena. Flipkart, the Times of India reported on Tuesday,  is building an in-house team while also exploring partnership deals with Mumbai-based PharmEasy to claim a share of the e-pharma pie before it’s too late.

Meanwhile, almost on cue, PharmEasy and Bengaluru-based Medlife, who share a common investor in Singapore’s state-owned investment firm Temasek Holdings, have approached the Competition Commission of India (CCI) for a potential merger of their businesses.

E-pharmacies, by market estimates, currently account for just under 3% of the overall pharmaceuticals market in India. According to Ernst & Young (EY), the e-pharmacy market is expected to touch $18.1 billion by 2023. Clearly, there’s enough headroom for many more players.

“After food and grocery, pharmacy is the only product which almost everyone needs on a regular basis… Collectively, these companies will only expand the market, and make room for many more companies,” Arvind Singhal, chairman and managing director of consulting firm Technopak, said.

The entry of large players such as Amazon and RIL, alongwith the momentum that several of the smaller players are currently seeing in the aftermath of the Covid-19 pandemic, is expected to shift the market more towards online models as far as medicine and away from unorganised chemists. Online platforms offer a one-stop solution for all healthcare needs, including drug delivery, medical devices, alternative medicines, diagnostics and consultation.

“If they (Reliance, Amazon) thrive and increase, the adoption of e-pharmacy will grow and it is beneficial for everyone. E-pharmacy is only a minute portion of the overall pharma market. There is so much catching up to do. Even if you take it to 15% of the market, that number itself is astronomically high. It's way more than the top lines of all companies put together. People should celebrate Reliance and Amazon coming on board,” Mohit Gulati, managing general partner, ITI Growth Opportunities Venture Fund, said.

Apart from Netmeds, PharmEasy and Medlife, other notable startups that have sprung up in the space over the past five years include 1mg, SastaSundar, DocsApp (which recently acquired MediBuddy, Medscape, and Mfine. Many of these firms have raised reasonable sums of private capital from investors such as IFC, Corisol Holding, Redwood Global, Fusian Capital, Bessemer Venture Partners, OrbiMed, and Sistema Asia Fund.

These startups offer a range of B2B and B2C services including medicine delivery, doctor appointments, telemedicine, diagnostics, insurance, drug information, healthcare content and records.

Despite the investor interest and the obvious opportunity that lies ahead, the going hasn’t been smooth for e-pharmacy startups. Their biggest bugbear is discounts. Discounts, according to the EY report, surpass the margins in the chain. Unless discounts are brought down to reasonable scales, profitability will remain a distant dream for e-pharmacy startups.

Cash burn is very high among e-pharmacy startups. According to some of the industry observers TechCircle spoke to, e-pharmacy companies suffer negative EBIT margins of about 20%-30%.

“Customers choose online players just for the discounts, but then online players keep discounting with each other. That is a never-ending process. These consolidations are primarily caused by lack of profitability. As consolidations reduce competition, online discounts would go down by 2-3%, which would help towards overall margin,” said a former founder of an e-pharmacy startup.

Without the burden of discounts and with an established supply chain and distribution structure, the mom-and-pop chemists enjoy a massive advantage.

The inherent supply chain vulnerabilities -- sourcing, product availability, margins, lack of technology, and lack of process automation -- are currently beyond an e-pharmacy company’s control.

The supply chain is broken and unstructured, making it hard to establish a standardized sourcing process across the country. For example, an offline chemist needs to store about 2000-3000 stock-keeping units (SKU) to serve in his immediate locality of 4-5 kilometres against an online player with pan-India presence who has to keep about 30,000-40,000 SKUs. 

It is an enormously challenging task to source and manage a supply chain of this magnitude. While the top 2000-3000 SKUs can be sourced by partnering with large manufactures, e-pharmacy firms are forced to work with smaller manufactures spread throughout the country to source the remaining products, which is a nightmare. It takes a lot of manual work.

Besides the management, the cost structures are hardly standardized. While the average order values are decent, the number of products needed to hit that basket size is very high, which also makes the process harder in comparison to another ecommerce segment.

“When the service of the retailer next to your house is technically better because they usually have most of the medicine you want, it becomes a problem. You need to differentiate yourself somewhere, the only option to differentiate is to discount. So when you are giving such high discounts, your margin takes a hit,” said an industry expert.

It’s a difficult chicken-and-egg situation. Larger pharmaceutical companies require e-pharmacy startups to attain a critical mass for exclusive partnerships. But to reach there, they would need better margins from pharmaceutical companies. It’s a vicious cycle, one that offers greater possibilities for large players such as RIL and Amazon.

Then comes the distribution challenge. The next phase of growth depends on how fast deliveries can be fulfilled. 

E-pharmacies have failed time and again to crack the delivery conundrum primarily because they do not own the inventory or the end-to-end supply chain. The new-age online delivery companies will find it hard to win much of a consumer mindshare unless they find innovative solutions to this distribution struggle and bring down the delivery within 60-120 minutes.

“When you are sick, you are not trying to score a medicine at 25% discount. You need a medicine which can heal you at the moment.  With its model of checking prescription, scheduling a call and dispatching takes a minimum of two days to reach you. By this time either you've recovered or in a bad state, hence for just in time the neighbouring chemists score higher. This is about 60% of the market,” Gulati said.

Setting up dark stores, like cloud kitchens, that can store the multitude of SKUs so that they can serve across the length and breadth of the city can be a potential model. This is capital-intensive and tech-intensive, which could work for deep-pocketed players such as Amazon and Reliance.

“It requires deep investments. Investment has to be made to maintain inventory. Unlike other categories of merchandize, this is very compact in terms of physical size and space from where you can deliver within one hour. The space requirement is limited in contrast with other categories like clothing or grocery. They can also employ legal pharmacists in these stores to check prescriptions and make sure orders are service right,” Technopak’s Singhal said.

While Amazon in its traditional build-from-scratch model might go for a slower pace, Reliance could make an attempt to bring together its many initiatives including its small store format ‘SMART Point’ outlets, biotechnology subsidiary Reliance Life Sciences, and Netmeds to enable pharmacy services across its physical retail stores and subsequently add pharmacy to the JioMart.

However, the challenge for Reliance is that being a listed company, it may not have the financial cushion that a traditional venture capital investor would have for its portfolio companies when it comes to customer acquisitions spending. Unlike what it did with telecom, the customer acquisition cost may or may not translate into long-term customer loyalty in ecommerce. Building a vertical domain is a long-term play in ecommerce. 

“Reliance doesn’t have a VC mind-set, they don’t believe in customer acquisition cost with regards to B2C business. Most indian customers are fickle minded, they would come in for discounts, buy and bounce off to the next platform that gives them a good discount. It requires a good DNA which the VCs in the US have had. Amazon was given almost 10 years to break even.  If Reliance burns large sums on acquiring customers in pharmacy, the stocks will get hammered,” Gulati said.

With their early mover advantage, e-pharmacies have created a high level of stickiness to their platform as they capture the entire health cycle of a customer. It would be an uphill task for new players to beat this competitive moat to poach their customers. Their domain expertise built over years of dabbling in this space cannot be replicated overnight.

“It all depends on how fast they can move, both Amazon and Reliance. For Amazon, it’s difficult to move fast. For Reliance, it’s the focus. It has entered so many industries, it will be very hard to focus on each of them. I believe it will take a long time for them to build a business and that gives vertical players enough time to grow to a decent scale and become substantial players,” an industry observer said.