What are the subscription plans?

As long as rental users get the service they paid for, they don’t care much for the brand either. And some manufacturers are already seeing that.

Water purifier maker Livpure Smart is already renting its product as a service rather than just selling it. “We want to sell water as a service,” says Sunalini Singh, assistant general manager of marketing for the SAR Group, which makes the water purifier.

Analyzing the subscription route

After launching its subscription plans in 2018, subscriptions from just two cities accounted for 3% of the company’s sales, says Singh. The reason for going the subscription route, she said, was to target millennials. It’s a generation that doesn’t want to shell out Rs 15,000 ($218) upfront for the machine, not to mention the annual maintenance costs.

The downside for Livpure Smart is that its service centers, which were once profit centers, are now cost centers since they’re tasked with maintaining the rented purifiers.

The service centers no longer make any money, admits Singh. But the silver lining, she says, is in that customer acquisition costs have dropped. “Traditionally, we acquire customers through advertising and that costs about Rs 3,000 ($43.7), but this is entirely through referrals, so costs are down to about Rs 1,800 ($26.2),” she says.

The company is now evaluating the launch of air purifiers on rent, too. Singh adds they expect 30-35% of their revenue coming from subscriptions in two years.

“Subscription is officially the most popular business model. It is growing at over 100% every year, and represents 30% of our deal flow,” says Sandeep Murthy, partner at Lightbox Partners, and an investor in Furlenco.

The tail that wags the dog

Manufacturers are starting to wake up to this new paradigm. Swedish furniture giant Ikea, for one, is also looking to build a scalable subscription service for furniture. It’s pitching this as a move to reduce waste and be greener.

For others, the writing is on the wall. The likes of Uber, home-sharing company Airbnb, and co-working space WeWork have convinced users that ownership is overrated.

Brands, too, have lost their sheen amidst a deluge of young, hungrier competitors looking to do more at lower price points. Samsung, which reportedly cut 1,000 jobs in India recently, epitomizes this trend.

It is losing market share to upstart rivals in the smart television segment. Smaller, nimbler television brands like TCL, Lloyd—by offering cheaper products—have captured 40-50% of the market, up from 10% three years ago, says the executive director of a consumer durables retail chain. He didn’t want to comment publicly as he does business with Samsung.

Hyundai’s recent decision to lease directly to consumers is a sign that manufacturers across sectors are taking notice.

But has the dam truly broken? Not quite. For manufacturers to also rent, it calls for a very different risk appetite that few have. “There is nothing common in the way manufacturers run their business versus rental companies,” says Ashish Goel, co-founder, and CEO of furniture maker Urban Ladder.

Nothing is common

“The type of product, financial model and operating model—nothing is common. You need very sharp financial engineering for this more than anything else,” he says. Goel estimates that to generate the same Rs 100 crore ($14.5 million), a rental company would need 3X more inventory than a manufacturer. Urban Ladder has decided to avoid the rental space altogether.

Smart TV maker Vu Technologies is similarly averse to space. “We evaluated rentals, but the costs involved make it prohibitive,” says Devita Saraf, chairperson, and CEO of Vu Technologies. “My margins will be wiped out if you take the logistics and maintenance costs. Unless it is going to count for one-fourth of our sales, we are not going to look at it,” Saraf says categorically.

But if ride-sharing and e-commerce foretell the future of the rental economy, manufacturers better keep an eye out. Eventually, manufacturers will have to sell with one hand tied behind their backs. “Large distribution channels will reverse integrate into producing products.

This will present a challenge for manufacturers as the distributor will wield influence on what products are consumed—think how Netflix/Amazon Prime shifted power away from content creators. The same thing will happen across industries,” says Lightbox’s Murthy. Renting, then, could wield more influence in the manufacturers’ fate.


How Ola recharges its electric ambitions?

“Bhavish is one of the most talented entrepreneurs in India today,” says Avnish Bajaj, managing director at Matrix Partners India, an investor in ANI Technologies Pvt. Ltd, which runs Ola.

“Just how many people can stand up against an investor like SoftBank?” asks a person who has worked with him, requesting anonymity, referring to Aggarwal’s battle with the Japanese investor who holds around a 26% stake in Ola. A conflict that came up yet again last week with reports on why the 33-year-old refused a billion-dollar investment from SoftBank, the Godfather of the Indian startup ecosystem.

Hustle brought in the company

But just guts and grinding will only take you so far. “He has worked hard and hustled, and that hustle has brought the company where it is today. But it may not take them to the next level. You need a different playbook, a different approach,” this person added.

Bengaluru-based Ola (ANI Technologies Pvt. Ltd), currently the market leader in India, and its founder have set their sights on an IPO within the next four years. And to get there, the company has gone into overdrive.

In March alone, it announced hundreds of millions of dollars worth of investments in new businesses—from “self-drive” (read car rentals) to “electric mobility”. And raised hundreds of millions more from new and existing investors. All aimed at turning the startup into a “mobility” company—not just a cab aggregator.

At the core of this strategy is a new bet on electric vehicles. Last month, the company announced that its EV subsidiary has raised $56 million from existing investors Tiger Global Management and Matrix Partners. Plus, Ola itself raised $300 million from South Korean automakers Hyundai and Kia as part of what it called a strategic partnership to work on developing India-specific electric vehicles and—more importantly—infrastructure.

This, in a country where almost every attempt to roll out electric vehicles at scale has either failed or been quietly abandoned. Including Ola’s own pilot in partnership with Indian auto firm Mahindra & Mahindra (M&M). And the government’s policy reversals (more on that later) haven’t helped.

Ola’s not alone in this—around the world, ride-hailing firms from Didi Chuxing in China to Grab in Southeast Asia to Lyft and Uber (which competes with Ola in India) in the US have launched a series of EV projects and announcements. Over the years, many of these, too, have petered out. But in the past few months, all of them have been back at it.

Can Ola and Co. get it right this time around?

Back in the saddle

Ola’s first dive into the EV pool was with a “multi-modal” electric pilot in Nagpur in 2017, in partnership with Mumbai-headquartered automaker M&M. The project included 200 vehicles—electric cars, electric auto rickshaws, electric buses—rooftop solar installations, charging stations, and battery swapping points.

All in all, Ola spent $8 million on the pilot, but it hit a snag—no driver was interested in the company’s newfangled EVs, as The Ken reported earlier.

Multiple roadblocks at once

According to a Reuters report last year, nine months after the project started, it hit multiple roadblocks. Only 22 of the promised 50 charging points were installed. Many drivers had either returned their vehicles and changed to diesel or were planning to do it, unhappy with long wait times at charging stations and high operating expenses.

“It is a pilot and there will be learnings for the company. There could be multiple reasons why drivers are returning vehicles,” says the person quoted earlier. “One, they are used to ICE (internal combustion engine) platforms and here they have to deal with EVs. These are behavioral shifts. You also need to understand that the country is not completely ready for EVs at this point.”

However, Ola, insist company executives and analysts, is dead serious about EVs. Its Mission Electric commits to bringing 1 million EVs on Indian roads by 2021. (A tough ask, given that while EV sales doubled to 56,000 units in the year ended 31 March 2018, they accounted for less than 2% of the 3.3 million passenger vehicle sold.) And through its Electric Mobility subsidiary, as well as the tie-ups with Hyundai and Kia, Ola seems to be confident that the solution lies in tech tailored to its own use cases.


How are the financial results analysed?

Secondly, gains from companies going public—primarily Uber, where SoftBank is the largest shareholder.

Finally, unrealized “paper” gains in companies whose valuations were marked up due to new investment rounds—notably OYO.

Therein lies the rub

Acquisitions such as Flipkart’s are rare, especially given the stage at which SoftBank enters these companies.

Public listings such as Uber’s are rare as well as whimsical. For one thing, large investors such as SoftBank are typically constrained from offloading their entire stake at the time of the IPO and can, at best, liquidate a part of their holding.

For another, public markets tend to value technology companies far more clinically than private investors by focusing on fundamental business metrics such as revenue, growth, and profitability rather than vanity metrics that got these companies huge valuations from VCs. This means that the value of the stake investors such as SoftBank hold in companies like Uber can easily be lower than their entry prices.

This leaves us with the third category of gains—unrealized paper gains that SoftBank has booked in companies like OYO. Last year in September, SoftBank led a $1 billion investment round in OYO that pushed the company’s valuation up to $5 billion.

What were the investments?

That figure is 13 times higher than when SoftBank first invested in OYO in 2015, according to investment data tracker Dow Jones VentureSource. This investment allowed SoftBank to record a 154.2-billion yen ($1.4 billion) valuation gain in OYO.

While this figure is only 12% of the overall segment income for the Vision Fund, notice that unlike the other portfolio companies where there were external market forces at play, the valuation gain in OYO was achieved simply by internal diktat. Considering the fact that SoftBank owns nearly 50% off OYO, any money that it puts into the company is akin to SoftBank taking money out of one pocket and putting it into another.

In turn, these unrealized paper gains allow the Vision Fund, and by extension SoftBank itself, to shore up its financial results. These stellar financial results, in turn, allow SoftBank to borrow more at better rates both at a corporate level as well as margin loans with shares of its portfolio companies as collateral.

SoftBank has a long history of availing margin loans using shares that it holds in companies such as Alibaba as collateral. At one point in time, the margin loans on Alibaba alone were worth more than $8 billion.

Notice that the high valuation of these shares allows SoftBank to borrow increasingly larger amounts of capital—while most margin loans are on publicly traded stock, it is not uncommon for bankers to arrange loans on private company shares as well. This facility lets SoftBank service annual interest payments to their quasi-debt LPs without requiring any real-world cash returns from its portfolio companies.

So essentially, SoftBank is using debt to service debt. Normally, this would be a classic debt trap, but SoftBank uniquely has the leverage to book unrealized gains and pump up numbers to the level it so desires.

In others, a Ponzi.

Layer cake

But this is not just any other Ponzi. This is a Russian-doll Ponzi, where there are multiple nested iterations.

How so?

Let’s take SoftBank’s original $100 million investment in OYO in 2015. Would OYO’s business fundamentals at that time justify a valuation of $400 million? Absolutely not. But that is how VC investing works in any case—you are investing for the future potential of a company rather than the current metrics.

So you could argue that the $400 million figure is justified as it factors in OYO’s potential to become a large budget hotel aggregator/operator in India—presumably a large market with a big opportunity.

But once that investment has been made, it bakes in these expectations. From that point on, it is incumbent on the startup to “grow” into that valuation by executing on its plans. The problem though is that markets are unpredictable—it takes much longer to penetrate and grow, competitors can take away your business and unit economics can turn out to be far more challenging than anticipated. So this might call for further investments.

However, it is difficult to justify higher valuations for these investments, given that the original hypothesis had already baked in the full addressable market size and opportunity.


How OYO outgrew Gurugram and conquered China?


Where does it stand in the Indian Universities?

That’s the number of rooms that OYO currently claims it has in China. Nearly double its Indian inventory. And this despite only landing in China as 2017 was drawing to a close. The number of rooms in China may seem astronomical, but, as OYO’s China CFO Wilson Li explains, scaling is relatively easy as the Chinese market is 10X the size of India’s. It’s growth, he says, that is hard.

OYO, though, will not be deterred. If the SoftBank-backed hotel chain is to achieve founder Ritesh Agarwal’s stated goal of 2.5 million rooms by 2023, China will be key. And it took yet another step in this direction with its first acquisition in China this past week, snapping up its smaller rival, Qianyu.

An efficient hotel chain

Qianyu, which loosely translates to ‘Thousand Islands’, is a mid-range hotel chain with a similar model to OYO. It targets individual hotel owners, bringing them onboard its platform and linking them under one cohesive brand. Launched in August of 2017, the company has nearly a thousand properties across more than ten cities in China, according to its website.

An OYO spokesperson, however, told this reporter that Qianyu’s operations will remain independent. Interestingly, for a company that practically infests India’s larger cities, 80% of OYO’s properties in China are in Tier 3 or smaller cities.

OYO intends to continue its brisk and unrelenting march across China. Swallowing up individual hotels and small chains as it looks to recreate its omnipresence in India in a foreign market. But how did OYO get this far in China? And how does it intend to conquer a market that, as Uber and Amazon can testify, is notoriously hard to break into for outsiders?

Finding bearings

OYO doesn’t try and hide its Indian origins. However, the way it’s run makes it seem completely local on the ground. “I couldn’t quite believe it when they told me the company was Indian,” said a security guard at a newly-branded OYO hotel in the port city of Tianjin. He had worked at the same hotel for decades before the owner decided to join OYO in August of 2018. OYO has about 6,000-odd employees in China, the vast majority of whom are local.

“I believe we are a Chinese company,” says Li. “There’s no hierarchical relationship between us and India. The decision-making is completely separate.” Structurally, the company is completely separate from the Indian entity. It is owned by parent company OYO Global along with a clutch of private Chinese investors.

In addition, OYO also secured a $10 million investment from Huazhu Group Limited in September 2017, around eight months before entering China. Huazhu Group runs one of China’s largest economy hotel chains, Hanting. This further bolsters OYO’s Chinese credentials.

OYO, though, has taken nothing for granted. Rather than announcing its arrival by making a big splash, OYO instead chose to test the waters. It began with trials in November 2017 in Shenzhen, China’s tech hub in the southern province of Guangdong. OYO approached and partnered with local hotel owners, surveying them periodically as they operated over the following months. By May 2018, OYO had the information it needed.

The trials showed that owners of standalone hotels were interested in what OYO had to offer, and there was a largely untapped market of these hotels. With its homework done, OYO set to work.


Can India’s On Your Own (OYO) crack Southeast Asia?

It is a tantalizing prospect. Expansion. A prospect knew to emerge, ever so faintly, in the fleeting thoughts of anyone who has ever started a business or harbored thoughts of lording over an empire.

Kings and Queens have been there. So have trading corporations. And brick and mortar companies, taking their manufactured goods to several parts of the world. But now it is the turn of the internet companies; unicorns who manufacture nothing but sell many things. This story is about one such unicorn in particular.

A company from India called Oyo Rooms, a budget hotel management company, which right now is on SoftBank steroids. To the tune of $800 million and a commitment of $200 million more. In its seven years of existence, Oyo has raised close to $1.7 billion. And so, it is expanding.

Initiation of World Domination

But if you are Oyo minus the blinkers of world domination, you’d do well to see that our contemporary world isn’t quite a walk in the park. Evaluated purely on the grounds of the experience of internet companies who have fought hard, access to finite capital resources and value creation for shareholders, the world is a far more complex place than it appears in press releases.

A quick tour should help put this in perspective.

China: Nobody does the business of any significance in China. Except for the Chinese.

The troika of Google, Facebook and Amazon know this well. Courtesy their exclusion from one of the largest markets in the world. Travis Kalanick, the ousted co-founder of Uber, learned it in a long-drawn brawl with Didi Chuxing, the Chinese ride-hailing company; a brawl which Kalanick eventually lost. Incidentally, late last week, Didi Chuxing said it is investing $100 million in Oyo. Both companies share the same investor, Masayoshi Son of SoftBank. The Wired magazine says Son is charismatic and he is eating the world, one tech company at a time.

The United States of America (USA): The US has an abundance of budget hotel chains offering standard accommodation. The entry of another player in the market does not move the needle. In fact, the last technology company to have disrupted accommodation in the US was Airbnb. This disruption, which has now gained legendary hustle status and a world domination story of its own, did not involve hotels.

Europe: While budget hotel chains are few and far between in Europe; geography does not have a quality problem when it comes to cheap accommodation. Hotels across all countries in the European Union (EU) follow stringent quality standards. Take standard 6205, for instance, which states that all 2-star, standard hotel accommodations must have a wine list with four quality wines. That’s a thoughtful gesture. Needless to say, it is also a world far removed from the state of affairs of standard hotels in India; one that necessarily gave rise to a company like Oyo.

Russia: Few Internet companies, from India or Silicon Valley, have thought of Russia as a market ripe for technology disruption. As far as the management of hotels by international players is concerned, the market is small. According to a study by the professional services company Ernst & Young, the total branded room inventory available in Russia as of October 2017—179 hotels with 38,705 keys in 387 locations—was operated or franchised by 22 international hotel chains. The largest market share (80%) was divided between five chains: Accor Hotels, Hilton Worldwide, Marriott International, Carlson Rezidor Hotel Group and InterContinental Hotels Group. Homegrown Russian hotel chains exist and are growing, as you read this.

The last notable tech battle in Russia was between Uber and Yandex, the country’s homegrown internet search company which operates several internet businesses. After burning $170 million, in 2017, Uber exited Russia by picking up a 36.6% stake in Yandex for $225 million.

South America: This is a region constantly in economic flux but favored by international hotel chains. For instance, South America is Accor Hotels’ third-largest market in the world. The company opened 52 hotels in the region in 2017 and is now present in eight countries: Brazil, Chile, Argentina, Colombia, Ecuador, Paraguay, Peru, and Uruguay. All put together, as of August 2018, the Accor group had 330 hotels and 52,000 rooms in the region. To compare, Oyo claims that as of October 2018, it managed 1,33,000 rooms in India.


Going Full Stack and not looking back

While the C2D segment has undoubted appeal, the unit economics has yet to be figured out. Cars24 may be the largest player in this category, but it’s unit economics aren’t great. To give a rough estimate, Cars 24 would earn about Rs 15,000 ($210) on a car purchase of Rs 3 lakh ($4,200). This goes towards several expenses—managing the store, salaries, warehousing, marketing, etc. Given the fact that Cars24 is still setting up stores, it’s operating expenses are higher, leading to losses. Experts feel that as these marketplaces scale-up, profit will soon follow.

“As more and more volume comes in, it will start making sense. There is enough opportunity both on the demand as well as the supply side. It is only a question of trust getting built in the system and more people moving online,” Says Nilesh Kothari, co-founder, and managing partner at venture debt financing firm Trifecta Capital. Trifecta is an investor in CarDekho.

Well-aware about the economics

CarDekho is aware of the poor unit economics but is willing to wait. “Structurally, the market will move towards these models (C2D). It is convenient for dealers to buy through these platforms and for customers to sell through them,” says CarDekho’s Umang Kumar.

The C2D is part of CarDekho’s full-stack strategy, wherein it will ensure that it has monetization at every stage. Aside from the 4-5% that it will make on the auction of each car, it will also get into a fintech play. The auto marketplace will essentially offer working capital loans to auto dealers looking to buy inventory. An expert from a company in the same space said that there is scope for decent margins here as CarDekho can secure loans from NBFCs at interest rates as low as 13-14% and offer it at markedly higher interest rates of 22-24%.

The chain does not stop there. Having an end-to-end model means that the car bought by the dealer may land up on CarDekho’s classifieds platform, which the company has steadily built over the years. Of course, the dealer could choose to list on rival platforms like Olx, which has a large horizontal classifieds business. However, if it is posted on CarDekho’s classifieds, the platform could earn more revenue by facilitating finance and insurance of the car. In this entire play, experts believe that CarDekho could end up making anywhere between 6-7% of the used car cost across the entire chain

Finance fantasy

CarDekho’s rivals though will be hoping to curb its rise. The company acknowledges that it will face significant competition. With CarDekho’s incursion on Cars24’s C2D turf, Cars24 will look to strike back.

Likely by going after CarDekho’s stronghold—classifieds, and more specifically the finance and insurance space. Although, it is currently only in Delhi NCR on the “buy” side, sources say that Cars24 is ramping up its presence and fundraising may be underway.

The finance and insurance space is precious to CarDekho. After all, this is where it has built its value proposition over the past few years. Realizing that it faced stiff competition from Olx from a pure classifieds perspective, it went about creating a niche for itself, offering things that Olx did not. Thus came warranties, inspection reports, certification, finance, and insurance.

CarDekho’s insurance business is growing at 20% month-on-month. In December 2018 alone, it sold 12,000 policies—10,000 more than it did the December before. Its financing business is also growing at a steady clip— with Rs 60 crore ($8.4 million) worth of loan disbursals in October 2018.

CarDekho’s Kumar feels that there is tremendous opportunity in finance, with the penetration being just 15% in used cars. He believes this could go as high as 40% in the next 5-6 years. As proof of the untapped potential in the segment, he gives the example of listed companies like Shriram City Union Finance in the vehicle financing space which have grown to become billion-dollar companies.


How Competition at its peak in India?

A large research firm that competes with RedSeer said that it is not in this market share game. “Frankly, we don’t understand how RedSeer comes to those conclusions,” says a senior researcher with the firm, who requested not to be named. “Initially we also thought we will do this, but then these companies just don’t give us enough data to work with so we said there is no point in this exercise.”

That doesn’t mean all of RedSeer’s intelligence reports or methodology pass muster. As part of the research for this story, I reached out to several startups. One particular story stood out. Where the co-founder of the startup requested not to be named because issues between them and RedSeer escalated to alarming proportions.

“I have been a consultant in my previous life,” says the co-founder. “I don’t trust their methodology and research reports. It is so immature that you can’t even answer the next-level business questions. Speaking to 30 people is not research, I can speak to 30 customers and get a better insight.”

Facing a terrible experience

He didn’t stop at that. “And I have had a terrible experience with them. One of our employees got several calls from RedSeer asking for confidential data. We had the calls recorded where the employee clearly told the firm that he has signed confidentiality agreements.

Then the RedSeer guy says, don’t worry we will help you manage legal consequences. That’s not done at all. Trying to steal our data saying we will help you legally? So we went after them. This employee got calls from Beeroute Research Private Limited. Anil Kumar is a director, you can check this company out on your own.”

The Ken looked into the antecedents of Beeroute Research Private Limited. It has no relation to RedSeer, except Kumar, who is a director of the company. The company hasn’t filed any financials for the last couple of years, and it isn’t exactly clear what research it does.

Not affected yet

It is another matter altogether that Kumar is unperturbed. He says RedSeer’s methodology is solid. It is not for nothing that the company has a team of 70 researchers, whose only job is to do phone interviews with customers. Each of these interviews is recorded, and any interview that lasts say less than five minutes of conversation is junked. If clients so wish, they can access all call records.

That’s not all. The questions are vetted by RedSeer to get specific answers. On top of that, the firm employs techniques of mystery shopping, field research, which is carried out by agencies, who work exclusively with RedSeer. Just so the firm can have control over the quality of data. “I don’t want to boast,” says Kumar. “We selectively hire from some of the best colleges in India because of the kind of company we are building.”

This is where we could use some consulting help. From R Srinivasan, a professor of strategy at the Indian Institute of Management, Bangalore (IIM-B) and who has published a paper on the consulting business in the country. In his view, it is remarkable what RedSeer has been able to accomplish in the time it has been around. “It is essentially a data research company,” he says. “And it is very rare to be able to provide research for both companies and investors looking at investing in those companies.”

Some companies not convinced yet

Srinivasan says that it is understandable why some companies find it troublesome. “This is a common problem in management consulting in markets which are very thin, where, let’s say, there are just five players,” he says. “The players will have an accurate sense of the overall market, where they can subtract their data from the total data and say this doesn’t seem right.

But as markets become bigger, these problems go away.” Srinivasan says that RedSeer has a bright future because it is now part of a wonderful, vicious cycle. Because RedSeer has access to data of companies, it can accurately predict where these companies are going to invest.

Simply put, RedSeer is playing on both sides of the table, almost influencing the cards both players will put down next.

Much of it is serendipity, and Kumar is the first one to acknowledge it. But then, he says, he isn’t going to rely on chance anymore.

What’s the battle of homestay?

But even the $31-billion valued company’s 40,000 listings number doesn’t hold up well when compared to competitors. While Airbnb does not disclose the number of rooms listed on its platform, taking an average of two rooms each gives the platform a rather liberal estimate of 80,000 rooms. Compare this with hospitality startup Oyo’s 143,000 rooms and it seems far less impressive. And if one looks at OTAs such as MakeMyTrip and Yatra, the number looks still smaller.

Is it really encouraging stat?

Besides, 40,000 listings are hardly a cheer-worthy number in a huge country like India which has cheap real estate and ample availability of second homes as well as first homes with hosts. South Korea, a country that’s a fraction of India’s size, has 37,100 listings (as of 31 December 2017). Thailand, meanwhile, has 61,400 active listings and New South Wales (NSW), a southeastern Australian state, has 54,900 active listings, according to data from the company’s official advocacy platform Airbnb Citizen.

A former Airbnb executive justified this saying that listings grow in proportion to the number of tourist arrivals. However, a cursory analysis of the 2017 tourism footfalls of different countries shows little correlation between the two. A glaring example would be NSW, which received just over a quarter of India’s 15.5 million tourists in 2017 yet has more listings. To truly make its mark in the country, Airbnb will have to up its number of listings. However, even if it is to push for more listings, India’s unique travel ecosystem may still put the brakes on Airbnb’s ambitions.

On a budget

Primary among the hurdles in the way of Airbnb’s path to market domination is the fact that India is a budget travel market. As such, Airbnb’s listings struggle to compete with the bevy of Indian budget hotels. According to a study by the Boston Consulting Group and Google titled ‘Demystifying the Indian online traveler’, mid-scale and budget hotels account for more than 50% of branded hotel rooms. Of this, budget hotels are expected to grow at 14% annually, the highest among all hotel categories.

Yatra’s Chief Operating Officer, Sharat Dhall puts it succinctly: “When someone is getting a room per night for Rs 700 ($10) with a guaranteed standard of service and complimentary breakfast, why would she bother to pay even Rs 300 ($4.25) more for a homestay,” he says.

The popularity and growth of budget hotels have only been helped by deep-pocketed OTAs and Oyo offering discounts and cashbacks. With MakeMyTrip raising $330 million in May 2017 from China’s Ctrip and South Africa-headquartered Naspers, and Ritesh Agarwal-led Oyo Rooms raising $1 billion in September 2018 from SoftBank and a clutch of other investors, the discounts and cashbacks are here for a while longer.

Dhall goes on to say that homestays are currently being driven mostly by experience seekers and leisure travelers. There is no experience angle in budget homestays, and that’s where it all falls apart. The market for experiential and leisure travel is currently very small, and that’s why homestays have not seen much growth.

In fact, one of the reasons the concept of alternate accommodation has worked well in the US, the UK, and many European countries is because hotels are expensive and homestays are cheaper. Unless the anomaly created by India’s budget hotels and fuelled by OTAs corrects, it is unlikely that Airbnb’s hopes for rapid growth will manifest.

Airbnb’s Bajaj says that the company is focusing its efforts on expanding its listings to include more price points, properties, and experiences to accommodate all sorts of travelers.

The complex world of homestays

Budget hotels are not the only speed bumps. There are other challenges inherent to the homestay market in India.

First up, there is the issue of service expectations. Indian travelers are not very Do-It-Yourself savvy and typically like to be served when on holiday. Many Indian hosts, unlike in the West, are not very clued in about standards of civic sense and sanitation, leading to an expectation mismatch and spoiling the homestay experience.


Why Oyo is parsing playbook one hotel at a time?

If one could paraphrase OYO’S elevator pitch, it would sound something like this: “OYO standardizes a highly fragmented budget hotel industry with consistent and uniform upgrades in infrastructure quality and service levels to ensure a consistently comfortable and reliable stay for the hotel guest and, in turn, enhance the occupancy levels, revenue, and profitability of the hotel owner”.

So, how does this play out on the ground?

OYO has a feet-on-the-street marketing team that stakes out budget hotels to find partners.

Approaching the right person

The hotel owner who spoke to us runs a budget hotel in North India. OYO approached him sometime last year and offered to take it under its wing on the following terms:

Following an audit report, the hotel would invest in upgrading the hotel to OYO’s prescribed standards.
The hotel would bear all the capex expenditure.

  1. OYO’s only upfront investment involved putting up their branding signage and other branding materials and providing a tablet device to be used for managing bookings.
  2. OYO would be responsible for all 35 rooms at the hotel. It offered a minimum guarantee of Rs 14.5 lakh ($20,400) per month (NB: This sum was arrived at after OYO examined the hotel’s legacy booking and occupancy records). This is the assured sum that OYO would pay the hotel irrespective of how much business was actually generated.
  3. Once this minimum guarantee fee was crossed, the hotel would need to pay OYO a commission of 20% of the excess revenue every month (17.5% as revenue share and 2.5% as “platform fee”)
  4. The booking process would work as follows: Customers book rooms through the OYO website or app or any other OTA/aggregator with which OYO has tied up (for instance, MakeMyTrip and GoIbibo). In addition to this, any customer can walk in and book a room at the hotel counter directly (these bookings would also count against the minimum guarantee).
  5. The payment and settlement process would work as follows: Some bookings are prepaid, for which OYO collects the payment upfront; others pay at the hotel itself (both pre-booked rooms and walk-ins). At the end of each month, the hotel owner is liable to pay 20% of the booked revenue to OYO—OYO consolidates the online and offline payments and settles the balance payment to the hotel after deducting its commission.
  6. The hotel is completely responsible for operating the hotel—OYO bears no operating expenses.
    On the face of it, it is a brilliant model with an irresistible win-win value proposition.

OYO gets additional inventory without any capex or opex—the textbook thin-asset business model.

The hotel owner gets a higher revenue through the increased utilization that OYO’s platform provides, as well as the comfort/insurance of a minimum guarantee that he will earn irrespective of what the actual utilization is.

All kosher, right?

On paper, yes.

On the ground, not so much.

How so?

Let’s examine the metrics one at a time (NB: These numbers are drawn from the actual reports and bank statements over a nine-month period shared by the hotel owner).

Occupancy rate

Claim/promise: Sharp increase (Before: 25%, After: 65%)

Actual: Moderate increase (Before: 70%, After: 80%)

OYO promises a nearly three-fold increase in room occupancy rates from 25% to 65%, but in reality, the owner saw a much more modest increase (from 70% to 80%). Of course, this might have been a function of the original occupancy rate which, at 70%, was already high, to begin with. Perhaps OYO’s value proposition is far sharper for hotels with vastly underutilized inventory. Be that as it may, the hotel owner was not particularly happy with the increase in occupancy.

Why so?

According to the owner, there was a marked difference in the profile of hotel guests before and after tying up with OYO.

Previously, a large chunk of them were corporate guests. Hotel owners prefer corporate guests because they are more profitable on multiple counts. Corporate guests are usually long-term partners with a higher level of loyalty and stickiness. Most corporate bookings are for longish periods—a minimum of three to four days.

Servicing corporate customers carries lower overheads, and most of these guests use the rooms primarily as a place to sleep at night and therefore don’t require constant care and attention in terms of housekeeping during the day (when they usually step out for work).


Analyzing and weighing the odds

And even for startups with relatively steady cash flows, debt can be a bit of a touchy topic. Because they know their cash flows are deceptive, at best, and won’t stay the same.

Imagine a ride-hailing company that has to give out more incentives for driver-partners because drivers threaten to jump to a competitor. It looks healthy one month, and the next thing you know, expenses go up, payments don’t come on time, and it goes into a downward spiral.

Utilizing digital technology

Which is why Ezetap, which makes point-of-sale or card payment devices, stayed away from taking on venture debt. Even though the company is well-funded and counts the who’s who of venture capital as investors—from Social Capital to Jonathan Soros. In 2017, when the company was evaluating venture debt, CEO Byas Nambisan (then the CFO) felt it was an unnecessary expense even though they wanted to expand their manufacturing capacity.

“We were in between fundraisers and the idea was that we can reduce the amount of stake we had to dilute by opting for debt. But I wasn’t comfortable with my operating costs going up. So we decided not to take it,” says Nambisan. Ezetap’s bank clients, he says, don’t always make timely monthly payments, leaving his cash flows less certain than needed for regular debt payments.

And sometimes, it is not all about the math on paper.

On paper, equity is a costlier form of capital than debt. While the cost of venture debt after tax deductions is about 10%, the “notional” cost of building a business via equity would be about 30%, estimates Trifecta Capital’s Kothari. And with equity deals, founders obviously have to part with valuable stakes in their companies.

But the reality is a little more complicated, especially for startups able to raise Series B or later rounds ($5 million-plus investment rounds, usually).

Right now, there are far more venture capital funds chasing Series B deals than there are “fundable” startups. The demand-supply mismatch, if you will, has seen startup valuations shoot up. This means that founders can part with a smaller stake for the same funding—reducing the cost of the capital to the point where venture debt’s relative cheapness isn’t attractive enough.

Making up with the unit economics

Moreover, debt makes sense if a company has nailed its business model and unit economics. Then it can be the fuel that will deliver predictable growth. But in India, there are few companies, even among late-stage startups, who have managed to do this by the time they hit Series B or C. This means capital is used for business model discovery. Something which venture debt funds find risky.

“We don’t invest in concept-stage companies. That kind of risk is for equity investors,” says Kothari.

All of this has made debt tough for startups to reconcile with. “Founders historically have developed a framework for using equity to grow. But debt comes with commitments to payback and they have a personal obligation (which is fair), making it harder to the stomach,” says Ashish Fafadia, a partner at Blume Ventures.

It explains why for some like Hari Menon, co-founder, and CEO of online grocer BigBasket, the rules for taking on debt are almost set in stone. Menon, a seasoned entrepreneur of 20 years, believes equity should be used to fuel growth and debt is for capital expenditure or working capital needs.

What is equity?

“Equity is the best way to double down on growth needs because you need large sums of it, something you can’t do with debt,” he says. BigBasket took debt only after its Series D round in 2016 when it had demonstrated the ability to generate consistent cash flows. And then too, it took less than $50 million, compared to the $886 million it raised.

And while Menon says BigBasket is in a position to take on more debt now, there’s another hurdle—there’s still not much venture debt capital.

Larger companies can get larger ticket sizes of debt only when the corpus of venture debt funds can grow to be much larger and portfolio diversification is possible, says Alteria Capital’s Murali. Today, Alteria is in the process of building a Rs 1,000 crore ($145.7 million) corpus, Trifecta, a Rs 1,500 crore ($218.5 million) one.

But the way venture debt firms in India operate and are structured still holds them back.