Startup Series: What economies of scale really mean for your startup

Phrases like "economies of scale" are easy to bandy about. What do they really mean for a startup? How do you safely scale up your business?

By Mahesh Bhalla

Last month, I wrote that in the recent past we have largely seen innovations in the ‘aggregation’ space. A number of start-ups mushroomed in the “discovery” space (e.g. find Chinese restaurants in your area) and “aggregation” space (order from hundreds of restaurants through our app). This same theme has extended to furniture, laundries, drivers, home improvement services, etc. and while the end product or service delivered is different, the core offering has essentially been the same. I am sure that we will continue to see more entrepreneurs focus on this area, even though the scope for innovation here seems limited, relatively speaking. And only time will tell which of them will be “successful” in the next 5-10 years.

One of the things in the aggregation space that is often overlooked is the basic concept of “unit economics”. If you are a food delivery company, are you able to make a single food delivery order profitable? As an example, if your average food delivery order is Rs.400/- and you have agreed on a commission / margin of 15% from the restaurant, is Rs.60/- enough for your end to end delivery cost? This has to include the fractionalized salary cost of the delivery boy, cost of motorcycle and fuel, and other admin related costs. It is often assumed that with scale will come cost efficiency, which is not true in every case, as scale brings its own complexities. A higher admin cost (organizational hierarchy, etc.), tighter regulations and higher insurance costs, greater focus on employee experience, etc., all of which increase costs and reduce productivity at the unit level. Before you plan to scale your business, do check to ensure that the economics at your basic unit of measurement makes sense. This could be single order delivery with fully loaded costs, or even your overall operations in a city, however you want to measure it. You should ensure that the unit economics make sense before you press the accelerator. Recently, an entrepreneur from Bangalore met with me for funding support to scale his start-up nationally. My advice to him was to make sure that his first city was profitable. With over 90% unsold capacity in City 1, it did not make sense for him to enter other cities unless he was reasonably sure that customers wanted to buy enough of his services and pay good money for them.

Moving on to a new line of thought on some of the new and emerging trends in tech:

Analytics / Smarter decision making: We have started to see some interesting companies like MuSigmain India which identified this need relatively earlier on and are now one of the leaders in this space. There are other younger companies like Innovaccer which are also doing some new stuff and growing quickly. This space is still under served, with a lot of companies (read ‘potential customers’) that don’t know what they don’t know. We have a lot of innovation yet to come in this space, along with wealth creation in billions.

Moving “Stuff”: If there is one area I am personally bullish about, it’s about streamlining and bringing in efficiency when moving things (people and products). Uber and Ola are excellent examples of disruption in the public transport space at unit n=1. Companies like Parrot have put drones to very interesting uses and Amazon’s experiments with drones are a precursor of things to come. Did you know that the largest cost element in Indian e-commerce deliveries is in the last mile delivery - about two-thirds of total cost? The cost for a courier company to pick up the package from a seller in city A, move it to their City A hub, and transport it to their hub in City B, is only one-third of the total cost, as packages move in bulk on these transportation ‘legs’. However, the last mile delivery (from courier company hub in City B to the customers’ house) is plagued by the lack of scale as each delivery boy can make only 25 “successful” deliveries per day on average, which is a huge cost in the overall scheme of things. There are several companies trying to solve this piece of the puzzle through some very creative solutions.

Payments: This is another sector that has seen a lot of buzz and yet has a lot of headroom to grow over the next several years. With the RBI requirement of Dual factor authentication, payments by credit cards are not as seamless as they are, say, in the US. Companies like Paytm have built large wallet and ‘card-on-file’ databases that provide a platform for easier consumer transactions for certain use cases. In the coming years, we will see innovation around payments and authentication through Biometrics and Aadhaar in India, and possibly even voice authentication.

The author is the President of Qwikcilver Solutions. He is an angel investor and actively involved in the startup space. The author does not have any investments or equity positions in any of the companies named in this article.

This is the second part in a series on the startup ecosystem in India. Follow this space for more.

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