Zomato in deep trouble?

Zomato Falling?

Falling price of shares of Zomato

(Pic-of the fall) 

23 July 2021, pandemic is going on, the whole country is scared, there is an atmosphere of fear everywhere. 

In the meantime a huge IPO is announced. Zomato - IPO worth 9367 crore rupees at a valuation of 1 lakh crore rupees. When this IPO came, this is what Rakesh Jhunjhunwala said, "1 lakh became 40000 in Zomato, but you will get after 5 years.  Do not sell now, otherwise there will be loss". And he was right. Today it is not even 2 years  and today the same stock which was trading at 116 rupees at the time of listing, today, it has come around 50 rupees. And within no time, 64% loss. The valuation of $12 billions has dropped to $5.7 billions.

Is Zomato about to go bankrupt?

Is Zomato about to go bankrupt? Or is there something going on with the company which most of the people don't know!

March 2022, when this financial year closed, Zomato had doubled its revenue, 4192 crores. And even today Zomato has 55% market share of India food delivery market. Zomato hyperpure, 270% growth, in 2022, Zomato earned 541 crore rupees from hyperpure. Business is growing exponentially but still even today, Zomato is in heavy losses. 

And the problem over here is, most of the people think that because Zomato is in loss, that is the reason, its stock price is 64% down. But it's not like that! Reality is something different. 

Zomato internal finance structure

So see, in order to understand why the Zomato stock is falling continuously, at the very first space, it is very important for us to understand, how Zomato is making money currently? So if you look very very carefully, this is how Zomato makes money!

As soon as the customer opens the app of Zomato, he sees a lot of restaurants there, and Zomato charges an advertising fee from the restaurants visible on top. 

After that, the customer selects his favorite restaurant, and places an order there. After that, the restaurant receives the order and starts preparing the order, after which the delivery boy of Zomato goes there and collects the order, and after that, he delivers that order to the customer. After which Zomato charges delivery fee from customer, and the restaurant who has delivered the food, Zomato charges some commission from it. 

Apart from this, Zomato runs Hyperpure under which Zomato supplies raw material to a lot of restaurants, and Zomato makes money from this also. Apart from this, there is one more thing which Zomato does and that is Zomato Kitchens. Under Zomato Kitchens, Zomato will set up a lot of cloud kitchens, through which Zomato will make huge revenue. So you see advertising fees, commissions, delivery fees Zomato kitchens and Zomato Hyperpure, all these things together makes revenue of 4192 crores. 

Where do Zomato Spends the Revenue?

But the most important question is, where does the company spends most of the money? So, if I give you an overview, these three things comes in the biggest cost centers of Zomato.

No. 1 - Outsource support costs.It includes all delivery manpower costs. In which Zomato is spending around 1986 crore rupees. 

No. 2 -promotional and advertising expenditure of Zomato, which is 1217 crore rupees.

No. 3 -Employee benefit expenses, in which Zomato is spending 1633 crores. 

If we add these three and other expenses, then the total expenditure of Zomato was 6205 crores. And this is a very big problem. 

Duopolistic Market: Zomato & Swiggy

I know, many people would think, 'wait  a minute, the Indian food delivery market is duopolistic. There are only two players, Zomato and Swiggy. And if you look at the losses of Swiggy, that is 3628 crores, which is double of that of Zomato. And if compare the cumulative losses of both the companies, the total losses of Zomato are 6726 crores, whereas the total losses of Swiggy are 22,820 crores, which is almost 4 times of Zomato. 

Now by looking at this, many people would say, because Swiggy is making heavy losses, so in near future, it will go bankrupt. And in the coming time, Zomato will dominate the Indian food delivery market. But if this is so, the why the stock price of Zomato is falling? What is the reason due to which the share price of Zomato which was operating at the time of IPO listing may never reach that price. 

Food delivery market, Worldwide

So to understand this, let's understand the food delivery market of whole world. So currently, in the worldwide market, the biggest competitors of Zomato are Deliveroo, GrubHub, DoorDash, JustEat, Delivery Hero and Meituan. But you know what the interesting part is, out of all these global apps, there is only one app which has made profit and that is Meituan. This is the  only company which has made profit of $643 million. And that too when their revenue was more than $15 billion. but the point over here is if this $643 million profit is compared to $15.5 billion revenue, then this is just 5% profit margin. And that too, of the player who is best in global market. So you see, technically it is such a business which operates on very low margins. Now I know what you are thinking. If it is like this then why Swiggy and Zomato both companies are increasing their losses? The answer to this is market penetration.

According to the data shared by Macsquare, in India, food delivery business market penetration is only 7%, which we compare to China, that stands out at 50%. So you see, if we look at this from growth perspective, for Swiggy and Zomato, still there is a big market left to capture.  But this is where, the reality comes in. 

Who operates food delivery market?

See, these three players operate in food delivery market.

No. 1 - The customers.Customers want the cheapest food possible.

No. 2 - Restaurants who want to pay commission as less as possible, and they want to get minimum penalty,Give food to these companies at least possible discount.

No. 3 - our delivery boys. Who want increased pay and income.

what it takes to operate for the company? How it impacted the results?

If we talk about only customers, keeping all players aside, then this is what the company has to bear.

No. 1 - Customer acquisition cost

No. 2 - Customers service cost. 

During Lockdown Era

What is the cost of serving that customer after acquiring him? And last and most importantly, its maintenance cost. What is the cost of customer retention? If we go back in time, when the Zomato IPO was coming, this is how their unit economics used to look. At that time, Zomato was making 23 rupees per order, but the most important thing over here is, most of the people didn't consider business environment at the time of IPO of Zomato. And this is what it looked like in 2021. In 2021, when COVID was active, at that time, restaurants were decreasing because of their closure. Whereas on the other hand, most of the people had started ordering more because when they were at home.

So the simple scenario over here is, restaurants are less and orders are more. But in this case, when restaurants were decreasing, so in order to survive, they decreased the rate at which they were ordering dishes, so that they survive their business. Now Zomato had a very sweet spot over here. Because it is getting food at less rates from the restaurants, because restaurants have to do something for their survival. But on the other hand, customers are willing to pay more. So Zomato was getting food in less rate and was selling at high rates to the customers. That's why Zomato was making good enough profits for itself. Moreover the customers who were ordering from Zomato at that time, they were not just giving money for delivery of food, but they were also paying for their safety. So technically at that time, people were paying more money, for their safety and their convenience. As a result of which, the unit economics of Zomato had become profitable. 

By the end of Lockdown Era

But at that time, the company was in looses, because they wanted to just expand and they were blowing money on promotions. But this is how, things changed after COVID. After the end of Covid, the number of people who were ordering from Zomato has decreased. Why? Because now they have more options available and They can go out. On the other hand, the restaurants which were few earlier have now increased. And the rate they were giving food to Zomato, they increased that rate to increase their profit margin. Now the catch over here is, the rate at which Zomato was getting food, has increased a lot now. And here Zomato can't push this cost to their customers directly, because after that they won’t buy.

Effect of Russia-Ukraine war

Moreover due to Russia-Ukraine war, the prices of crude oil has increased. As a result of which, the delivery fee has increased a lot. So to balance this out, Zomato increased their discount rates. The more discount they increased, the more that food has become expensive. So technically, the food is available at same rate for customer. Customers think that they are getting very high discounts. 

Moreover, because less people were ordering food from Zomato, so to increase this number, Zomato had to put in more money in advertisement expenditure. As a result of which, Zomato increased their revenue a lot, but along-with that, their losses also increased. 

In the shareholder letter of 2022, Mr. Deepinder Goyal and Akshant answered some of the questions of shareholders. When they were asked about the progress of average order value of this year and last year, so this is what they said. The average order value of last year was 397 rupees, which has increased to 398 rupees. And it was justified by the statement 'we don't see any material downward pressure'. Similarly, like I have told you, the unit economics have completely changed.

The unit economics have completely changed

Can't believe? So here is the answer for the unit economics. When shareholders asked them, 'can you share detailed unit economics for the quarter so that we understand the break-up of contribution margin? Then this is what they said. 'We want to tell but we can't tell because of competitive reasons'. But the reality is India is a price sensitive hyper competitive environment, and that is the reason, is very difficult to sell high ticket product, until and unless it has high perceived value in the mind of the people. And if we talk about food, then these food delivery applications they have very limited ways to be profitable. Why? Because if you increase the prices, then this is what will happen in the India market. Now try to understand the Indian customer. Swiggy and Zomato, both companies have these two types of customers.

No. 1 - Their regular customer. And 

No. 2 - those customers who sometimes order from their apps. 

Those who are regular customers, are either very lazy or very busy. Those who are ordering regularly have selected restaurants from which they order their food. Now the thing over here is, as soon as these app increase their prices a lot, then their regular customer would prefer to buy directly, until and unless they are very busy. So the reality is, as long as Zomato and Swiggy continue to give regular discounts to their regular customers Till then they will keep ordering from them. Whereas on the other hands, those who are their irregular customers they don't care much about discounts. They are only on the application because they have a lot of variety of options. 

Now the point over here is, if companies give no discounts, then in this case, maybe their irregular customers would stay, but their regular customers would prefer to buy the food directly. And they will stop ordering. 

So you see, even if the company cuts its customer acquisition cost, which are promotional and advertising expenditures, still the company would have to bear the cost of retaining that customer, otherwise they will loose the customer. And as you can see, only one company in the world is able to become profitable, then think yourself, how hard would it be for Zomato. Because food delivery is such a  market which has very low profit margins. Moreover there is one more cost which would be uncontrollable for the company, which they push on the customers ultimately, and that is the delivery cost.

But wait a minute. Zomato has hyperpure, and they have Zomato Kitchens also. So with its help, Zomato can create a good profitable business by setting up its cloud kitchen everywhere and controlling the entire supply chain through Zomato Hyperpure. Right? Once they do it, share price will increase! Well it is 50% right and 50% wrong. 

And I'll tell you why! Just have a look at this data. The revenue of Zomato Hyperpure doubled in last one year, which is amazing. But if you look at their looses, then their losses also doubled along-with their revenue. And moreover Zomato Kitchens is such a thing which is new for the market. And if you talk about the stock market, the share price of any stock depends on the sentiments of public, and it happens when public consider a lot of factors. So until and unless the public believes, that Zomato has a very good future, till then stock price won't go up! And the most important thing, as retail investors, what are those such things which we should consider if we invest money in a company!

No. 1 - Look at the buyers before the sellers. See, before investing money in any company, we should see the past, present and future buyers, that who those customers are! Where they live! What their psychology is! How their spending habits are! How their lifestyle is! And a lot of such things. Because see, this will not just give you a perspective about the company, but also the business environment in which the company would operate, or is currently operating. 

No. 2 - Never ignore the financials. See, there is nothing free in this world. There is a cost of everything. So, money is very very important. No company can run without money. If the company is claiming that they would become profitable in the future, then in this scenario, there is a very big uncertainty attached to it. 

If you want to invest in a loss making company, then in that case, you should check these three things. 

No. 1 - What's the lifetime value of the customers of that company? 

No. 2 - What's the customer utility value of the product for that company?  

No. 3- what kind of spend psychology they have? 

See, customer utility value and customer spending psychology, both things get combined and make customer's lifetime value. If that customer's lifetime value is more than the customer acquisition cost and customer maintenance cost, so in that case, there are chances of being profitable in coming time. And last and most importantly, 'Don't put your money in something which you don't understand'. See, a of companies come in the market and a lot of companies go from the market. But most of the people invest in the companies which are famous. 

Conclusion on investment

Without even understanding the fundamentals of that company, what its financials are saying, in which business environment that company is operating, how the management is of that company, how the stock trend of that company is moving, they invest money in that company because of its name and without understanding anything. Why? Because that company is famous and everyone is investing in that company. See, if you invest money in the company without understanding their business, then there are very high chances that you'll end up loosing all your money! Maybe you make profit or maybe you make loss, but whatever would happen, would happen accidentally with you! And the thing is, you will loose a lot of opportunities during this process, which you could make profit by investing money in company after gaining knowledge. So as an investor, always study about the company before even investing a single penny in that company.