The greater fool theory seems to be at work in Indian e-commerce - The Daily Reckoning

The greater fool theory seems to be at work in Indian e-commerce

Jun 23, 2015

- By Vivek Kaul

Vivek Kaul
I have recently started using Uber and absolutely love their service. The cabs are clean and air-conditioned. Over the long distance UberGo, the most basic service that the company has to offer, works out to be cheaper than the ubiquitous kaali-peeli taxi in Mumbai.

Further, in other cities where the auto-rickshaw drivers are a pain in the ass (not that they are not in Mumbai, but the degree is considerably lesser), Uber is a real saviour. I used it during recent trips to New Delhi and Bangalore and totally managed to avoid travelling by auto-rickshaws. At airports, one is forced to take a radio-taxi or a pre-paid service. These services work out to be terribly expensive.

Last week, while travelling from the Bangalore airport to the city, I booked an Uber. A distance of close to 50km cost me Rs 578, which was around 50% of what a radio-taxi would have cost me.

Similarly, while travelling from the New Delhi domestic airport terminal to the sub-city of Dwarka, after midnight, I paid only Rs 173, for a distance of around 12 km. A radio-taxi would have cost me at least Rs 450, which would have included a night charge as well as a parking charge.

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So, the question is how is Uber able to offer services at such low costs? How are their costs even lower than that of the Mumbai kaali-peeli?

In fact, Uber-Go is priced at Rs 8 per kilometre in Mumbai. Over and above this there is a base fare of Rs 45 and Rs 1 per minute for the total time for which the journey lasts, that needs to be paid. I have asked every Uber driver that I have travelled with (even drivers of their mid-level service called uberX) whether the price being charged by Uber was economically viable for them? And all of them have said no.

"So how do you make money then?" is my next question. "The company pays us an incentive for every pick-up," is the universal answer that I have received. I don't know what the exact amount of this incentive is because different drivers in different cities have given me different answers.

But what this tells us very clearly is that Uber is under-pricing its services. What Uber is doing in India is similar to what the dotcom companies did in the United States in the late 1990s and the early 2000s.

As Gary Smith writes in Standard Deviations-Flawed Assumptions, Tortured Data and Other Ways to Lie With Statistics: "A dotcom company proved it was a player not by making money, but by spending money, preferably other people's money...One rationale was to be the first-mover by getting big fast...The idea was that once people believe that your web site is the place to go to buy something, sell something, or learn something, you have a monopoly that can crush competition and reap profits."

The idea is to get people used to Uber and then gradually start raising the price. In fact, Uber is not the only company in the Indian e-commerce/mobile-commerce space which is following this strategy. Discount is at the heart of the so called Indian e-commerce revolution. And given this none of these companies like to talk about their net profit or even their 'real' revenues for that matter.

The e-commerce companies like to talk about their "gross merchandise value" instead of revenues. And what is that? It is essentially the sale price charged to the customer. So if a site selling airline tickets sells 10 tickets at an average price of Rs 5,000 each, then the gross merchandise value is Rs 50,000.

What is the problem with this approach? Howard Schilit explains this in Financial Shenanigans-How to Detect Accounting Gimmicks & Frauds in Financial Reports: "Some New Economy companies have stretched the limits on appropriate revenue recognition by recording an amount far in excess of the service fee." Schilit then explains the statement using numbers of a company called, which is in the business of selling air-tickets and bookings of hotel rooms (Something similar to what, etc., do in India).

"For its efforts, pockets the difference between the amount received from the actual customer and the amount that has to pay to the airline or other supplier," writes Schilit.

Now how should it book its revenues? As Schlit writes: "Consider the following example. sells a $160 airline ticket to a customer for $200, keeping the $40 spread as its fee or the matchmaking service. What is Priceline's revenue for providing this service-$40 or $200? Priceline records the "grossed up" amount of $200, raising questions about the quality of its reported revenue."

Priceline should not have booked the amounts it owed to the airlines(or the hotels for that matter) as its own revenue simply because these "costs are merely a pass-through". Further, given that Priceline serves as an intermediary matching the airlines and hotels, with prospective customers, it should have been booking only its fee/commission as a revenue.

This is precisely how the concept of "gross merchandise value" works. And this is how Indian e-commerce companies have been jacking up their revenues. This is not surprising given that most of the big Indian e-commerce companies are owned by American investors. The model of reporting numbers that was followed during the American dotcom boom is now being followed in India.

A report in The Economic Times points out that some e-commerce companies have been pushing up their gross merchandise value by buying expensive goods being sold on their websites, themselves, under other names.

A higher gross merchandise value helps these companies get better valuations from investors, who are not exactly stupid, but seem to be egging the companies along in this game. The greater fool theory seems to be at work. Investors seem to be working with the belief that they will always be able to find a greater fool in the days to come to whom they can sell their investment and move on.

The problem is whenever the greater fool theory enters the game, things don't end well. Meanwhile, I will keep enjoying my Uber rides and so should you because for end-customers the deal is still very good. The good thing is that unlike the American dotcom bubble, the Indian retail investor is still not a part of this bubble.

But my guess is that this might change in the days to come as investors in e-commerce companies will try to exit their positions and force these companies to come up with initial public offerings. Ultimately, the retail investor will turn out to be the greatest fool-as is usually the case.

Stay tuned!

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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8 Responses to "The greater fool theory seems to be at work in Indian e-commerce"

Amit swami

Jun 24, 2015

Hi Sir,
I am not just one of your reader but a student. I have been following you since your DNA days.
Your words really carved me and your name itself is upmost to me.
Time to test your child is upto or not.
I just read about your uber trip. And i did my homework.
I want to share some interesting facts.
I live in Jaipur here the incentive to the driver for uberX is ₹1750 & uberGo is ₹1550. For that they have to just complete two rides one before 12 PM and second before 9 PM and if they do more they get complimentary approx 100 bucks on each ride.
Now the trick, the drivers manages to get two rides by themselves by using their own uber app. which doesn't cost them more than ₹150 and ₹ 1750 is credited to their account.
It accounts to ₹52500 a month which covers all the cost & handsome profit.
It's win-win for the driver. A driver with brand new car can break even in just few quarters.

Now the consumer, with first free ride then free rides on referrals & lots of other offers & coupons & multiple accounts as it's not hard to make an account with an email id and mobile number, rides are really at deep discounts.

John Forbes Nash,a beautiful mind is no more but his work benefit mankind " Governing Dynamics, Do the most suitable thing for you & for your environment ". Game Theory.
The start up is messing up. the service provider, the consumer are winning but here the broker is losing which is not suitable, the broker, the house must win.
Bet equal to Monopoly, oligopoly, cartel, market share,valuation, hopes.
But equal to Monopolistic, perfect,competition, me too, losses.

Benjamin Graham “a speculator is one who runs risks of which he is aware and an investor is one who runs risks of which he is unaware.”

Rounds and rounds funding like shots and shots & hangover or initial public offer.
The greater fool theory or the Ponzi scheme.
Investors are left in lurch or unaware.
As these can't go beyond mathematical equation of rational exponential function i.e. (x)power2 less than infinity.

Ola,Uber,Meru,TFS, hype & overvaluation, odds are against them.
Any kind of crisis will create contagion and wipe them out.
Maybe fuel crisis, maybe political-geopolitical, maybe regulatory hurdle.
Cost overruns, lack of funds.
Because these two will become demanding wife, the driver and the rider.
Then the operator will be taken for a ride.

I hope you liked it .

I am addicted to reading financial jargon and for me it not the jargon but the financial literature.

I wish for that you keep me going by saying like son i want you to write on this topic that issue, it will nurture me, I am deeply passionate about writing.

You will make my dream if you will reply.

And especially for you on our Guru - disciple relationship.

एक शब्द है जो तुझसे बना हैं,
खुदा ने तुझे सजाके लिखा है I
- अमित स्वामी

Yours sincerely,
Amit Swami


Girish Patkar

Jun 24, 2015

Without doubt e-commerce business is here to stay and grow exponentially. The question is about the quality of business in which investment is happening and basis of valuation. Investors who are paying top dollars for Companies based on metrics other than free cash flow, have deep pockets and lots of patience. They can exit if they find another buyer or hold on to investments. Ultimately not all Dot.Com Companies folded. Those with good business models and deep pockets are successful Companies today.



Jayanth Kumar

Jun 23, 2015

It is interesting to see the comments on 'Gross merchandise value'. As per my understanding, this is the system adopted by the traditional brick and mortar companies also. If the company is a trading company, the value of goods sold is taken as the turnover, even though the net margin available for the company may be only about 5% of the invoice values. Jayanth Kumar



Jun 23, 2015


Re- revenue recognition by eCommerce companies

In order to compare ecommerce companies with other retail operations (supermarkets for example), we need to see whether they use similar numbers.

If supermarkets record gross merchandise value in the same manner as the ecommerce companies, then the only difference is in how the inventory is managed, and all else is comparable.

Going by your logic, since today most car companies or electronics companies focus on design and marketing, and use partners/integrators to build stuff - then everyone should only talk about value added. This is also what they report to the government, for VAT.

As long as we know what they are doing, and what margins they are making, nobody is being fooled.

The foolishness is in expecting retail margins to justify such astronomical valuations. Take Amazon, US as an example - look at it's finances and it's value. The issue is the markets - even when they are wrong, they can be wrong for long enough to bankrupt you!



purushottam das gupta

Jun 23, 2015

Is there is no responsibility of C A and FCA .What are doing CS of the companies and other regulators . Isn't it required another sharper teething regulator to controlled it .

Like (1)

Dinesh Nair

Jun 23, 2015

Excellent, thanks you!

Like (1)


Jun 23, 2015

The piece of insights..Wow!!The great fool theory.

Like (1)


Jun 23, 2015

Very nicely articulated. The dangerous greater fool theory spreading tentacles across many sectors now..I have heard Ola is already feeling the pinch and just not able to get out of their incentive schemes and run operations. But one thing is for sure, even as this fool theory unfolds and companies that remain after disaster will benifit for sure, just like Amazon did in US. For the uber, what he wants is get critical mass of drivers. His incentive scheme is based on nu of trips drivers make and not all drivers get incentive. He might capitalize on the money made from drivers who didn't qualify for incentives.

Like (1)
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