The Business Times' Column | Due Diligence: How to Assess a B2B Marketplace

Piyush KHARBANDA | 20 Feb 2023

This column was first published on The Business Times

IN the past decade, we have witnessed tremendous growth of Business to Business (B2B) commerce platforms across South-east Asia and India. Gartner estimates B2B online marketplaces are forecast to account for 40 per cent of the global online retail market within the next five years, with Asia being the key market driver.

This is not surprising – micro, small and medium-sized enterprises account for as much as 97 per cent of all businesses in the region and employ 69 per cent of the workforce.

Yet, for many of these emerging economies, their B2B value chains remain largely inefficient. One of our main investment theses is that platforms connecting smaller businesses, from wholesalers and traders to payments, supply chain management and lending, present a massive opportunity.

They create value by providing access to technology and tools as well as designing innovative business models that help smaller players improve their operations, increase efficiency and reach new markets or more customers.

And we have seen some early successes within our portfolio that have recently achieved unicorn status – in Nium, a global money movement solution for businesses; Patsnap, an IP intelligence search platform; and Xpressbees, a logistics platform in India.

Building an effective B2B commerce platform is challenging

“Isn’t it just copying and pasting the Taobao model into B2B? What’s so difficult about that?” one might ask. But we have seen this being attempted many times with no success. Trying to remove the middle-man has proven not to be an easy feat after all.

To thoroughly appreciate this challenge and opportunity, we need to first understand that the small business segment is very unique. Firstly, they behave like both individual consumers and corporate customers. It is thus not easy to build a truly self-serve platform.

Typically, we see “managed” platforms as being more successful and hence, we have invested in Grab (mobility, South-east Asia), Aruna (seafood trade, Indonesia), Fairbanc (fintech, Indonesia), Janio (logistics, South-east Asia), Manuva (manufacturing, Indonesia), SCB Abacus (fintech, Thailand), Turnkey Lender (fintech, global) and Validus (fintech, South-east Asia).

Secondly, the business model is not easy to scale. For instance, the most “efficient” unit of retail is the kirana in India, the mama shop in Singapore, the warung in Indonesia, and the shohuay in Thailand. In many of these stores, there is no rental owing (real estate is usually owned and close in proximity to the customers), no wages to pay (the entire family works at the store), and no leakage or wastage (truly entrepreneurial).

It is difficult for a corporate store to compete with this setup, in terms of unit economics and operational efficiency. It is even more difficult for a chain of corporate stores to compete with a disparate group of stores in large cities like Bengaluru or Jakarta.

However, as one scales up a store by increasing Stock-keeping Units and adding slow-moving inventory, the inherent advantages break down, and a very interesting opportunity in the form of a larger format modern retail concept presents itself. The same situation is observed in retail wholesalers and distributors, and several other segments.

Capable entrepreneurs can create a tremendous amount of value. However, access to excess capital can be an Achilles heel. The B2B set-up is best built on frugality, finding tiny pockets of inefficiency and scaling those, whilst kicking out incumbents in the process, and ultimately making a lot of money in the bargain. An abundance of capital has meant that an organisation is not singularly geared towards milking the margin in the value chain.

Startups need to navigate the complexity of a managed marketplace

Providing a marketplace that facilitates commerce between small businesses requires more than just a simple matching exchange providing informational transparency. The marketplace typically needs a certain level of “managed service”.

Such a service can range from a simple one like an escrow account or quality control of buyers or sellers, to more complicated functions like payment terms and working capital, customised design, supply chain management, etc.

Some of such services demand specialist skill sets. For instance, payment terms require the knowledge of financial risk management, supply chain optimisation requires operational specialists, and customised design requires niche consultants. These services are important to entice users or reduce friction for customers to switch from their current business partners.

However, the implementation can be rather complicated for technology startups. It needs a lot more than just lines of code. The important point is that investors and founders need to be realistic about what can be realised by technology and what can’t. Many just assume all services can be automated and digitalised.

Optimise not on vanity metrics, but the true margins

While evaluating B2B e-commerce platforms, the conversation between entrepreneurs and investors seldom moves beyond the topline, mostly classified as gross merchandise value (GMV) or gross transaction value (GTV). We have observed that GMV discussion hides the core driver of business value, which is margins.

To start with, some definitions. GTV less the cost of goods is the gross margin (GM). GM less the cost of fulfillment is the contribution margin. Adjusting for logistics cost is an important criterion in assessing B2B commerce platforms.

There should be an added nuance: margin analysis should also compensate for working capital.

Here is a simplistic approach: assuming that the platform can potentially get working capital financing at 18-24 per cent per annum, we should ascribe a 1.5-2 per cent additional cost for every 30 days of working capital in the value chain (divide the above by 12 months). So assessing the number of net working capital (NWC) days is somewhat of a journey as a company scales.

Therefore, the true definition of margins in B2B commerce is the logistics-adjusted and NWC-priced gross margin. Startups need to have healthy margins to be venture-backable.

Maximise operating leverage

Traditional B2B operators such as wholesalers and traders have tremendous operating leverage. The flip side is that they often suffer from an inability to scale teams, but are constantly trying to grow topline, resulting in an ever-expanding free cash flow.

B2B commerce startups, however, may not do well on this aspect. When the topline grows by x dollars, their operating costs typically increase at the same pace.

Unlike businesses such as software-as-a-service, B2B commerce has a significantly lower gross margin to begin with. What increases costs is founders’ tendency to add warm bodies (raising employee headcount) to solve problems. Most companies in this region employ armies of people to call up customers for every part of the business: placing orders, tracking shipments, confirming receipt, and chasing for payments.

Being able to grow customer accounts without the need to add an army of account managers will be core to cutting cost and improving operating leverage.

Piyush Kharbanda is a General Partner at Vertex Ventures South-East Asia and India.

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