I’m trying to alternate between posts with a positive investment outcome and others where we end up passing. My initial post was on passing on the RNPL sector and my previous post was on why we ended up investing in Calo.

This post is on why we decided to forego (mostly…) investing in B2B marketplaces and other relatively low margin businesses. This ended up being a wider conversation on margin, particularly product margin and its relationship with demand/revenue generation, the trade-off between the two and how we think about that in general and in specific to B2B marketplaces.

If we cast our mind back to 2018-2022 period, a new type of business appeared to have become de jure in emerging markets, specifically B2B focused marketplaces. I’ll outline here out thinking around this segment.

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Business model

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Problem:

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Supermarket/grocery/foodstuffs retail market in emerging markets is fractured and unstructured:

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· Highly segmented demand: Very long tail of small corner shops/small independently owned supermarkets that are unconnected digitally to their suppliers most importantly FMCG (P&G, Unilever, etc.)

· Inventory issues: unclear demand/inventory management and supply chain Complexity in managing order books, ordering for large FMCGs when connecting with small digitally unconnected/non digitally native retailers who are managing their supply chain on pen and paper/excel. This leads to retailers having less clarity over their own suppliers and inventory

· Complex logistics: Logistics/fulfillment/delivery have added complexity given that visibility over orders is unclear for the suppliers that must create wide ranging distribution networks to these retailers. For fresh product this is further exacerbated because of spoilage of fresh products and the needs for cold storage and just in time delivery.

· Price and availability issues: Inefficiency in the market reflected at times in lack of availability of stock or price distortions.

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Market structure:

• Depending on the region, corner stores are still a major contributor to emerging markets.
• In both Egypt and India, they contribute up to 90% of total grocery market sales
• In Africa, about 70% of FMCG products come from corner shops.

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Solution:

Digital platforms/ marketplaces that connect retailers with central suppliers.

The digital platforms allow retailers to order / manage inventory from suppliers giving them clearer visibility on their inventory requirements and for the suppliers allows them to have a direct/instant connection with fragmented retailers.

In most instances the fulfillment between the suppliers and the retailer is taken on by the marketplace/platform and they are responsible for the logistics component whereas previously it was the suppliers/FMCG/CPGs that were handling fulfillment.

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Varying Models:

These businesses are not monolithic and the business model I’m discussing typically manifests in several forms as follows:

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· B2B FMCG/CPG: Most common variety, typically connecting small retailers in dense urban environments with FMCG and CPG suppliers. Typically provide both parties of the marketplace with a software solution for inventory management/ordering. May or may not have a logistics/fulfillment solution which affects margin and cost structure, capital requirements/burn and operational complexity.

· B2B F&B Ordering: Similar to the above but focused primarily on suppliers to restaurants/F&B outlets and no/limited logistics/fulfillment function.

· B2B agricultural produce: Same as above but unlike FMCG requires more complex logistics due to cold storage and short shelf life. Furthermore, in most emerging markets supply (farms) are also fragmented where most suppliers tend to be small lot farms.

· Others: There are also other forms that are either variations of the above or specific adaptations to a sector but for the purposes of this discussion am limiting myself to the above three

Some common characteristics of these businesses:

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· Very fast acceleration of GMV (Gross Merchandize Volume). Not uncommon to see companies scale to $100m - $250m GMV in under 18 month – 24 months.

· Low take rate c. 5% or lower, i.e. conversion to GMV to revenue is relatively low. Typically (depending on the company) the GMV to Net Revenue to Gross Profit is accounted for differently. But typically, from GMV to Gross Profit (particularly product margin) you typically have a very low margin <2% and typically in the Seed to Series B Stages under 0% and in negative territory.

· FMCG Staples: Choice of product assortment/SKUs offered on these platforms tended to be staples with high consumption but low barriers to entry (flour, rice, sugar etc). This allowed high GMV growth but compounded low margin issue

· High cash burn owing (typically multiples of revenue early on) owing to low margin plus complexity in building out logistics/fulfillment and tech product.

· Focus on building ancillary business models/new products (often fintech related) with higher take rate/margin to boost revenues. E.g. Once a network of supermarkets has been built, focus on building a lending solution to the supermarkets’ given that the b2b marketplace has full visibility over inventory and movement of goods and/or financing inventory. Other examples include providing inventory SaaS management tool for a fee as an additional service. One more thing to note that many companies in the space were very much actively chasing topline growth with limited focus on take rate/margin. The idea being that the ancillary business models noted above would drive revenue and profitability.

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Arguments for and against

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For:

·      High volume and high momentum businesses. The ability of these companies to scale quickly as mentioned above is impressive.

·      Theoretically, solves one side of a problem which is giving small retailers a better way to manage their supply chain and inventory with suppliers

·      Given high volume, gives ability in theory to build ancillary businesses given high volume and high penetration/footprint into a segment of the economy that is under served given that they are digitally unconnected/relatively off the grid (financial services for underbanked SMEs)

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Against:

·      Typically, very low product/gross margin in the sub 2% range for initial years and on core offering/service

·      If it includes fulfillment/logistics also includes operational complexity. Many don’t “own” their fleets/3pl but effectively manage it/lease it. This while may be somewhat asset light/lower capex still requires operational complexity in managing last mile for long tail of smaller retailers

·      Weak(er) value proposition

·      High cash/funding requirements

·      Limited global success stories

·      The ancillary businesses that could theoretically drive revenue and profitability were also capital intensive (lending to buyers on these platforms would require huge amounts of equity and then eventually.

Conclusion

We ended up passing on the sector. This led us to a wider conversation on margins and what insights can be derived from a company’s margin structure on its relationship with its customers/stakeholders.

The product margin, as the first level in the margin stack, we view as basically a stand in for the strength of the value proposition of the product/service itself  to the key customers/stakeholders. What does this mean for B2B marketplaces:

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· Low take rate/low margin: indicates that the value itself is relatively low to the stakeholders. The take rate is primarily being taken from the FMCGs/suppliers. For them the value proposition appears to be taking the headache of reaching the fragmented retailers but it is not valuable enough for them to pay much for because they already have a distribution network. Therefore, are the B2B marketplaces really innovating on the model or merely at times subsidizing the suppliers and providing a small convenience.

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· Only one side of the marketplace is paying: Difficult in extracting margin from retailers. For retailers, it is difficult for the B2B marketplaces to extract any margin on the core service because for them it becomes more of a convenience / nice to have that is no doubt valuable but not valuable enough to pay significantly for.

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· High elasticity to take rate: Decreasing exponential relationship between margin/take rate and GMV. Indicates further that the suppliers are increasingly sensitive to any additional increases in margin (this is the case in some of the examples we’ve seen but not all. Where the take rate increase there is disproportionate willingness of suppliers to transact on the platform

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One consideration for founders:

Interesting thing here for founders in the space looking for product market fit to consider is as follows: at its simplest form margin/take rate is basically a stand in or analogue for how valuable your service/product is. If you are selling a product the amount of margin extractable is a good indicator of the value that the product/service has for the party to which the product/service is being provided.

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Final note on the  role of VCs:

One other thing to note, I think a lot of VCs during that 2020-2022 period fueled the growth of GMV at any cost approach. They pushed their underlying companies to grow topline to maximize valuation as the ZIRP environment + Covid related tech related irrational exuberance meant that markets were rewarding topline and forgetting everything below GMV/revenue. The advice for founders here, don’t always listen to your VC and don’t always think about the next round (while important it’s not that the most important thing). Always focus on building a great businesses that has clear intrinsic value. This value can be demonstrated in take rate/margin or can be demonstrated in other metrics -  but GMV growth with negative margin is a bad metric for long term viability and a negative indicator overall

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