Do low cost businesses create success stories? - Views on News from Equitymaster

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Do low cost businesses create success stories?

Feb 29, 2012

India is a country where one can expect a low cost business model to be a path breaking success story. And rightly so. After all India has got such an enviably large consumer base. And everyone knows that low priced goods and services should ideally work well with the consumers. Little wonder that we have the Air Deccan, Tata Nano, just to name a few. On the similar lines we also have 'Aakash', the government of India's dream tablet computer. The Aakash is a low-cost tablet computer which was originally projected as the world's cheapest tablet at a price of US$ 35 per unit.

But if you compare the price of these -Air Deccan, Nano and now Aakash, with the other peers, you may wonder as to how these low prices are possible. Well, the answer to this is compromise. The manufacturing company may end up compromising its profit margins or the quality of products or both. And this is what defines the success or failure story of the business in the long run.

Let's start with the much-talked-about Rs 1 lac car, Tata Nano. Even before its launch, the car was touted to be a huge success story which would completely change the landscape of the automobile industry. But unfortunately it never even created a dent. Initially it faced several technical problems. Though Tata Motors (Telco) made several modifications and came up with a much better version. However, Tata Nano is still miles away from being a huge success story. And come to think of it, it still does not come at much coveted price tag of Rs 1 lac. The only saving grace is that Tata Motors has deep pockets and the muscle strength to try and make Nano big at some time in the future.

Low cost airline, Air Deccan was another 'big story' considered to be one of the most robust business models in the aviation industry. However, it could not sustain the business for long. It was eventually packed up in 2007 and the business was sold to Kingfisher Airlines.

India's dream tablet, Aakash does not appear to be faring any better. There are several complaints such as the processor is too slow, the battery life is too short and the resistive touch screen is hard to use. Due to a dropout between the government and the tablet developer, DataWind, currently there is no clarity as to who would supply the next 1 million units at such a low cost. The government is planning to launch a new tender for the same. In the process, chances are that the initial developer as well as vendor for the tablet DataWind could be dropped.

It is true that ultra low cost business models are good for consumers. And if they are executed properly, they could be the next big growth driver for the company. The company can make profits out of this on the back of high volumes which offer a good operational leverage to the company. Operational leverage means that the company employs a higher proportion of fixed costs and a lower proportion of variable costs for its products and services. So cost for manufacturing products or servicing customers goes down on per unit basis with a growth in volume. However, the business idea must be feasible and sustainable.

From the investor perspective they have to keep a few things in mind before buying into such stories. First thing to ask is, is the business model feasible and sustainable or is it just a new advertising campaign to generate consumer interest? Second, what is the commitment by the company towards the model? Are they willing to stick their necks out and do everything possible to keep the business going? But in doing so, would they be hurting investor interests? Or will they just pack up and abandon the project altogether?

India has a history of creating affordable products with good success stories. Generic versions of pharmaceuticals are some examples. However, Investors would do well to study the prospects of the announced plans more carefully before investing in such companies. It is best not to just get carried away with the projected success story of the idea. Otherwise it could just be another flop story.

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