In mid-July, Zomato, a grocery delivery company, listed its shares on the Indian stock markets. The initial public offering (IPO) was oversubscribed 35 times, which equates to a value of $ 12 billion. Why does a loss-making company – with no real estate or assets – have such a high valuation and attract global prominent investors like Fidelity, Morgan Stanley, the Canadian Pension Fund and the Singapore government?
Although Zomato runs a traditional grocery store, Zomato embodies a modern technology company. Like DoorDash and SkipTheDishes, it delivers ready-to-eat groceries to households without owning farms, grocery stores, restaurants, warehouses, trucks, or delivery vehicles. The business model is similar to that of other tech companies like Uber, Amazon, and Airbnb, but is subtly different from Facebook and LinkedIn.
In a previous HBR article, we claimed that WeWork is not a technology company despite claims to the contrary. WeWork’s failure to go public and Zomato’s success can teach us what a modern tech company is and what isn’t. In our opinion, a successful modern technology company can transform entire industries, expand and reach at breakneck speed, and make huge profits without the need for significant capital investments. It usually does most, if not all of the following six functions.
Rapid industry transformation.
Zomato aims to change the eating habits of 1.36 billion people in India, where 90% of the population does not eat in restaurants. Compare that to China, where 58% of people routinely eat in restaurants. There used to be two barriers to eating out in India. The first was pure logistics: only 2% of Indian households own a car (compared to almost 98% of US households). The second was a cultural taboo: some people would never eat food cooked in someone else’s kitchen.
Zomato takes both of these hurdles. It gives a new segment of the population access to restaurant food by having it delivered at the push of a button. It also breaks down cultural barriers by encouraging users to provide feedback – people will be less reluctant to try restaurant food when they see their own family members or people from their own caste and peer groups doing so and food recommendations and give restaurants.
While many of us are familiar with a food delivery app, Zomato may not be less ambitious than what Uber or Airbnb set out to do to transform the eating habits of large numbers of people. Uber provides ridesharing to millions of strangers and now employs more cars than any other taxi company in the world. Airbnb makes it easier to stay in someone else’s home and offers more rooms than any hotel chain in the world. Thanks to these companies, people don’t have to own their own kitchens, cars, and houses to enjoy their privileges. This virtual shared property creates value for people by improving the use of assets and reducing the risks associated with property ownership.
Low cost of capital yet extremely valuable local assets.
Google Search, Airbnb, Yelp, Uber, LinkedIn, and Facebook have one thing in common: They have scalable virtual models that can be expanded exponentially with just a few additions. This is unlike a company like Ford or Target that needs land, factories, distribution centers or warehouses to expand. In other words, tech companies can expand their revenue and income statements with little addition to their balance sheets. Zomato, a multibillion dollar company, doesn’t even have an office.
Nevertheless, Zomato differs from other tech giants in one important point: Companies like Google and Facebook can serve a foreign country without having a physical presence there. In contrast, Zomato only enters new cities after building relationships with local restaurants, evaluating their offerings, and working with them to improve their menus and prices. It also identifies, evaluates and appoints local delivery agents. Zomato therefore invests large sums of money in local relationships and local knowledge – soft assets that competitors cannot easily replicate.
Modern technology companies collect, store, organize and analyze years of user data. This data is virtual gold as it enables companies to serve targeted ads and personalize the customer experience. The main difference between a customer entering a Walmart supercenter and Amazon’s online store is that Amazon instantly reorganizes the entire store (layout, displays, product offerings, etc.) to be tailored for that customer.
Likewise, Zomato or Uber Eats can track a customer’s tastes, needs for discounts and preferences in terms of cuisine, delivery time and price, and combine these insights with local food trends, seasonality and holidays and festivals to instantly offer a bespoke menu. This degree of customer proximity increases the switching costs for customers and creates significant entry barriers for new players.
For most modern technology companies, the bigger the network, the more valuable the company. There are three types of network effects: direct network effects, indirect network effects, and data network effects. Tech companies like Facebook and LinkedIn benefit from direct network effects. Every new customer who joins Facebook or LinkedIn creates value for an existing customer as both customers can now make direct connections with each other, even if they are in different locations. The thousandth customer to join the network creates more value than the tenth, fiftieth, or hundredth customer because the thousandth customer can create 999 new links while the tenth can only create nine links.
Tech companies like Netflix, Amazon, Uber, and Zomato have no direct network effects. When a new customer joins Zomato, they do not create a direct new connection with existing customers. Likewise, a new restaurant joining Zomato does not add value to existing restaurants using Zomato. However, in a bilateral platform like Zomato, there are indirect network effects. The larger the number of customers, the higher the value for restaurants and vice versa. Now customers have more choice, restaurants have a larger market and the delivery network can be used more efficiently.
More importantly, Zomato benefits from data network effects. Every new customer and restaurant contributes valuable data that Zomato can use to improve the value proposition for all existing users by improving the quality and depth of feedback, understanding usage habits, optimizing logistics, fixing bugs and stocking up on local flavors and preferences is expanded. Machine learning is constantly improving these insights. Zomato can now provide more personalized recommendations to each customer and better connect restaurants to their target customers based on collective learning from the entire customer base. This improvement, coupled with the increase in the number of delivery workers and restaurants attracted to the larger market, improves product and service options while reducing costs. Zomato calls it a “flywheel effect,” and every new customer and supplier that joins the network adds to the dynamism of the flywheel.
Ecosystems that encourage expansion at minimal cost.
A modern technology company can use its relationships with its customers to offer new lines of products and services. Companies that rely on the assets of ecosystem partners can do this at little additional cost. See Apple’s use of the iPhone and Amazon’s use of Echo devices to sell apps, music, games, and videos produced by third parties – all through their own payment services. Apple and Amazon then take a share of every dollar that goes through their systems. As another example, Uber has expanded its ridesharing service to Uber Eats with minimal investment. Zomato can also expand its range of restaurant food to include pre-sorted, ready-to-cook ingredients; In fact, it is already using its relationships with restaurants to source ingredients for them. Zomato also reserves tables for customers in its partner restaurants by offering tailored recommendations based on customer information.
Variable costs and margins.
Google Search, Microsoft, Twitter, and Facebook can grow their revenue with minimal variable costs. It costs relatively little to make another copy of Windows 10 or serve another Google or Facebook customer. For example, Facebook’s gross margins are 80-85%.
However, the same concept doesn’t apply equally to Uber, Airbnb, Amazon, and Zomato. Large chunks of their earnings are passed on to suppliers such as restaurants (Zomato), motorists (Uber) and homeowners (Airbnb). In addition, Amazon and Zomato have to pay their delivery staff.
But improvements in size, knowledge of suppliers, and increasing bargaining power lower these variable costs. Futuristic technologies like drones, robotics and autonomous vehicles can further reduce delivery costs. Increasing the scale improves the economics of the units – the profits made from each new unit of transaction – by improving revenue and lowering the cost per unit. Rapid growth thus becomes an integral part of the corporate strategy.
It is noteworthy that “tech” companies with little investment that display these six characteristics have received high ratings in the 21st century. As of July 2021, the combined market cap of FAANG companies (Facebook, Apple, Amazon, Netflix, and Google) plus Microsoft is nearly $ 9 trillion, which exceeds the GDP of all but two nations in the world. So Zomato’s high rating shouldn’t come as a big surprise. After all, it’s a proven tech company looking to change the eating habits of a billion-dollar nation.
The technology giants of today must be contrasted with the industrial giants of the 20th century: Ford Motors, General Electric, Dow Chemicals, Standard Oil, Union Pacific, etc. These companies have also transformed industries and societies. They required major investments that took decades to build. Although a technology giant of the 21st, how easy is it to gain the trust of 1.5 billion Facebook subscribers and reproduce the relationships, networks and personalized data?