B2B Marketplaces: Digitizing the Long Tail

An attempt at understanding the supply chain aspect of digitization

Small & Medium Businesses (SMB) have always been a critical part of India’s growth story. Depending on which research report you refer to, the total number of SMBs in India range from about 60–100 million and contribute a significant portion to the total Indian output, especially in the manufacturing and agriculture & allied sectors. It is thus critical that this segment digitize rapidly, if we are to truly unlock India’s potential as an economic superpower. Challenges remain, but solving them will be half the fun. With that in mind, let’s dive in!

While the services sector’s contribution to GDP has risen from 45% to 55%, manufacturing has largely plateaued at 15% in 2017 and only 17% in 2022. The Indian Government has repeatedly tried to change this and in a recent industry address Commerce & Industry Minister Piyush Goyal even asked industry participants to assist in increasing the contribution of manufacturing to 25% of GDP. The Government for its part has been pushing with its “Make in India” campaign, coupled with various manufacturing sops such as the PLIs, DLIs, FTAs and promotion of FDI.

One missing piece in all this is the lack of access (to demand, pricing information, high-quality suppliers, credit etc.) that Indian SMBs face on a daily basis due to the fragmented and hence inherently opaque nature of the landscape. Offline intermediaries dominate here. Solving these problems and bringing in efficiency are a whole host of B2B startups and tech platforms that have cropped up in the last few years.

Tech-enabled marketplaces disintermediating traditional sourcing/supply channels, circa 2022.

Why now?

India is at an inflection point in manufacturing and supply. A mixture of geo-political and macroeconomic factors has put our country at the forefront of a new manufacturing growth story driven by:

1. Rising disposable income fueling increasing domestic consumption
2. Government’s focus on self-reliance (Aatmanirbhar Bharat and Make In India)
3. Twin-pronged increase in government incentives (via PLI, DLI, Free Trade Agreements, export promotion etc.) and a digitalisation/tech push across India (via Aadhar, UPI, BharatNet, Jan Dhan, etc.)
4. “China+1” or C+1 where businesses have started avoiding investing solely in China and diversifying their business into other countries including India.

India’s B2B ecommerce market is one of the fastest-growing in the world, and is expected to reach over $1 trillion by 2024 — John Curtius, Partner (Tiger Global)

Who are the players then?

According to a recent Matrix Partners report, the B2B startup landscape has already received over $8.5 Bn of funding in the last 8 years and given rise to 6 unicorns, and over 24 companies valued at a $100 Mn+. Stellaris VP has also put together a nifty map of the B2B landscape which is shown below.

Source: B2B Commerce — Landscaping the Opportunity

B2B players in India can be broadly categorized into those offering multi-product categories and those specializing in one or two sectors. Udaan and Bizongo offer several sectors, while Infra.Market, Medikabazaar, Moglix, and Zetwerk cater to narrower segments. Infra.market supplies building and construction materials, Medikabazaar supplies medical/healthcare goods, Moglix supplies industrial products, and Zetwerk serves manufacturing and heavy engineering.

How are they adding value?

In a conventional supply chain, manufacturers produce goods, which are then purchased by large distributors and sold in smaller quantities to smaller distributors or end customers, such as SMBs. However, this model faces various problems, including issues with transparency, consistency, and reliability. The COVID-19 pandemic presented a great opportunity for the above players to disrupt this traditional supply chain model. B2B companies emerged and provided end-to-end transaction fulfilment by offering higher quality products, reasonable prices, consistent delivery schedules along with reasonable credit terms. These improvements have led to a more efficient and reliable supply chain, benefitting both the businesses and end customers.

How would you evaluate these players?

1. GMV vs GM — The Gross Merchandise Value (GMV) of a business is recorded as revenue on the books while the take rate charged by the platform is recorded as Gross Margin (GM) instead of Net Revenue. This differentiation is critical if you are valuing a company on the basis of a “revenue” multiple.
2. Growth (duh!) — The obvious metric here would be growth of GMV. An initial growth of 3–4x moving to 2–2.5x annually should give enough comfort to any investor. However, simply looking at overall growth may not provide a complete picture and thus the next metric becomes important.
3. Cohorts — Growth occurs via two ways: addition of new customers and increasing, repeat platform-usage by the existing customers. This is where the magic of cohort analysis comes in handy. While Demand Side (buying/sourcing on the platform) is important, the Supply Side (sellers on the platform) is critical as this will determine if the growth is sustainable or not. Why Supply matters is discussed in more detail in the Learnings section below.
4. Contribution Margin (CM1 vs CM2) — CM1 or ‘margin post delivery’ should always be positive. This shows that your platform is being used for its inherent value add and quality and NOT because it is a cheap channel for sourcing. CM2 or ‘margin post marketing’ can be negative initially but must show a clear path to positivity. A steady-state EBITDA of 5–8% may be possible in the B2B segment and a positive CM2 will help reach that number faster.
5. Working Capital — WC days, especially receivable days are key. If the receivable days are above normal (maybe 40–60 days), it means the participants are treating the marketplace as a “credit provider”. One should think of such businesses as financing businesses, rather than true marketplaces or platforms in this case. Commerce then simply becomes the GTM for driving lower acquisition costs in the lending business.
6. Working-Capital Adjusted CM — As we can see, the Working Capital is a critical part of the evaluation. Hence, it is critical to build this WC cost into the margin itself. One way is to take a very simple approach — assume that the platform can potentially get working capital financing at 18–24% per annum, and therefore, ascribe a 1.5%-2.0% additional cost for every 30 days of working capital in the value chain.

Inherently, investors should look for businesses that can create a high(er) contribution margin with the least amount of working capital.

A reliable way to check if the platform is adding value is to see if (a) the cohorts are growing and (b) the platform is thus used for things other than just financing. For this, it is critical that the supply chain is fragmented and unbranded. Only then can a marketplace/platform add value by bringing in discovery, quality, pricing, consistent delivery etc. Such a market also has no “MRP” and the platform can then drive its own pricing and thus get higher margins. The platform’s goodwill and value-add thus drives more business leading to a virtuous cycle.

If the Supply Chain trusts any particular “brand” on the platform/marketplace rather than the platform/marketplace itself, such a B2B business does not “add value” and hence cannot drive high margins (and thus eventually a large outcome). Should the demand side ask for a particular “brand” it may be an indication that the supply chain is already consolidated and that brand may then control the pricing. Investors beware! To counter this, a few players have introduced private labels, helping them expand margins and build customer ownership.

Learnings from the evaluation of B2B companies

We have evaluated over 15 companies in this space and distilled our learnings as given below:

• B2B has to be vertical and not horizontal. Horizontal platforms work well in B2C (think Amazon, Flipkart etc.) where the same customer can buy a myriad of things and cross-selling opportunities are abundant. In B2B, the customer set is vastly different (a textile SMB is not going to buy Steel) and synergies are limited. Different verticals require different buyer and seller workflows and monetization schemes .It is hence important to capture a market/segment/industry completely before expanding horizontally.
• The Total Addressable Market (TAM) needs to be large. Businesses expand horizontally and into adjacencies rapidly in order to showcase larger TAMs to investors but this needs to be seen in the context of the above point.
• Credit is key and needs to go on top of Commerce. Supply chains have problems with managing working capital needs and struggle with creditors who will lend at reasonable credit terms, if at all. Thus it becomes important to solve for the credit bottleneck as well. In the B2B space, customers seek comprehensive solutions that encompass financing options as well.

• Credit is also hard. The sales cycles for each market/segment/industry are different as are the funding and working capital needs. Initially, most platforms de-risk this off the balance sheet via tie-ups with NBFCs and banks. However, as they expand, most look to start lending themselves in order to capture some of the margins. Being verticalized here helps to bring in predictability of cashflows. If you expand into new segments/industries, getting a Head of Lending/Credit early on (even before applying for an NBFC license) is critical to manage the risk.
• Experimentation needs to be done early rather than late. A/B testing is a myth in this space as B2B cycles are too long. “Move fast and break things” while you are small as it becomes exponentially difficult to do so at scale.
• Once again, the supply chains need to be fragmented and unbranded. You may start with consolidated suppliers to build the initial logistics, quality control and drive sales but then go into the “long tail” as only this will drive the business. Remember whom you are adding value for. Ask yourself repeatedly “how are you different from a wholesale distributor?” B2B will always be a “supply first” business.
• Fragmentation is a feature not a bug. The more fragmented your supply chain (both on the demand and supply side), the stronger will be your eventual moat. It is very easy for any competitor to burn $$ for CAC and take away your suppliers or buyers if the base is small in absolute number. Successful marketplaces will deal with fragmented, mid-sized SMBs on the supply or demand side or both.

Matrix Partners has also created a funding napkin that can serve as a guide for investing in the B2B space. It is shown below.

Source: Matrix Partners — “Digitizing Make in India: A State of the B2B Sector Report”

Trends, White Spaces & Questions

The next stage of B2B companies will be those that go beyond industrial manufacturing, construction, and exports (some interesting names are GoMechanic, ElasticRun, Bijnis, Waycool, Vegrow). Other potential opportunities could be in Fashion/Apparel (like Fashinza), Yarn (see The Yarn Bazaar), Chemicals (Raw Materials) and Seafood (CaptainFresh is an interesting model).

Emerging areas beyond platforms could potentially be:

1. Those building tech for B2B (SaaS, IoT, innovative devices)
2. Logistics geared for B2B — multiple players are already emerging here (vs B2C which is already well discovered)
3. Exports / Cross-border — Build in India, sell to the world or assist those working across borders (e.g. Drip Capital)

The only question here is can India deliver high quality manufacturing consistently and within given timelines. This is the only way India can be seen as substitute supplier that adds value beyond simple price arbitrage. ESG compliances and regulatory uncertainty remain key risks to watch.

Conclusion

Venture Monk’s view remains what we started this article with — while challenges will remain, resilient founders solving them is what is exciting about the B2B space in the first place. It is imperative that India continue to invest consistently in capability development. Constant visibility of Indian professionalism and capability on the world stage are the way forward. India needs to be seen as a factory to the world that can provide high quality and not just cheaper pricing. The possibilities are tremendous and we look forward with excitement at the future.

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