ZOMATO : A CASE STUDY IN THE INDIAN IPO FRENZY - Muskaan Kedia

A few years back “start-ups” and “entrepreneurship” used to be the buzzword. Times have changed and having braved the black swan event of the COVID-19 pandemic - India today stands at the brink of the IPO dawn. A frenzy, rightly so with the biggest IPOs being listed and hundreds of thousands of participants flocking to them in their next quest to “chase their dreams” and build “wealth”. Speculation aside and without debating on the aptness of the term “frenzy” for the current scenario, in this article we look at an outlier. One among the most talked-about IPOs this year. The company that resonates with growth - Zomato. 

So, what is the reason for Zomato to be listed at the mega valuation that it was and why do investors have an optimistic outlook towards it? How is it different from Swiggy and is it in fact even prudent to compare it with Swiggy? Going forward, we engage on these questions and others to understand what the value drivers of Zomato are and what developments need to be kept in mind.

When you think of Zomato and its business model off the top of your mind, what is the vague idea that comes to mind? Well, in my case before doing a deep-dive study into the strategy of the company, I thought of it as food delivery and restaurant aggregator. In essence, I thought it charges a commission on delivery and that is how it makes money. That’s it. Is that what you think too? Well, in part - yes. This is true. But there is more to this than meets the eye. And that would make sense, right? Because, if there wasn’t anything more to it what would justify the “crazy valuations”? At the end of the day, theoretically, at least - the intrinsic value of the share is equal to the Present Value (PV) of the future cash flows.

The secret sauce to the euphoria around Zomato lies in “Zomato HyperPure”. It is a B2B initiative that Zomato hopes to use as the trump card to generate more wealth and sustained growth than can never be accomplished by the simplistic aggregator model. To understand what this is and why it will serve as a game-changer it is important to understand the supply chain of restaurants. 

Let's engage in an extremely simplistic thought exercise. Suppose, you are a restaurant owner and you only serve two dishes - Dal Makhni and Butter Naan. Now, let's try to prepare an inventory of the raw materials required to completely prepare just these two dishes. Let’s start with dal - here, we would need lentils, milk, ghee, tomatoes, kidney beans, chilies, garlic, clove, cardamom, cinnamon, chili powder, cream, and the list goes on. Let’s also look at Naan - we would need flour, curd, oil, black cumin, butter, etc. Basically, a lot of different ingredients are required and they fall into different categories ranging from vegetables to dairy products. 

Intuitively by now, I am sure you have an idea where this is headed. Yes, for all these different categories - we would require different vendors. On top of that the shelf life of different ingredients would vary significantly and when dealing with a variety of complex flavors and concoctions all while maintaining the quality and taste of the delicacies - inventory management becomes a hassle for restaurants. They often have 3-5 vendors for each category of raw materials in order to get the cheapest bids. This means that the orders that they place are staggered and not in their entirety from one supplier itself - which would not only reduce lead time but also empower the restaurants to bargain owing to their higher ticket sizes. 

This is where Zomato HyperPure plans to carve out not just a niche for itself but to gain a massive market share and capitalize on it. It is a B2B service wherein Zomato has built large warehousing facilities to buy such raw materials in bulk, which would lower its procurement costs and then become a one-stop solution for the restaurant owners. Since Zomato itself would be buying the raw materials in huge quantities and for massive discounts - it will be able to pass it on to the restaurants. Furthermore, the AI and ML facilities that Zomato has access to will better help it predict the aggregate requirements and the individual requirements of the restaurants. This will help it to better improve both its and its affiliate restaurants’ efficiency. 

Therefore, this model would act as a win-win for both Zomato and the restaurants that become a part of this ecosystem. Also, the other aspect to this is that of contract farming, by way of which Zomato can enter into contracts with farmers for high-quality products and pay them a predetermined amount. It could also outline in the contract the specific requirements down to the T. For instance, it could specify which insecticides and fertilizers are to be used and their respective quantities along with the irrigation technology to be used. This would mean that on its app as well Zomato could brand restaurants as having procured their raw materials through HyperPure - indicating the superior quality of the meals and thus warranting a premium from the customers. 

This in essence is the reason that has been driving the valuation of Zomato and now we very quickly look at the potential risks with this model. First, Zomato like JioMart will require restaurants to cut ties with all their other suppliers. This might be a major hindrance since the relationships that restaurants develop with their suppliers over the years are based on trust and breaking all ties with them would leave the restaurants highly vulnerable to Zomato. Next, is the credit policy offered by Zomato. Whereas from the traditional supplier, the restaurants could expect to extend their credit cycles and payments by up to 60 days interest-free, that would not be the case with Zomato. It will charge 1% interest for the first 15 days from the date of missing the payment and beyond 15 days an additional 0.1% interest for each day going forward. This makes their credit terms undesirable for the already struggling restaurants and therefore makes them wary of falling into a potential debt trap. 

Keeping in mind the above points of discussion, one this is for sure - it would be interesting to follow the Zomato story. If it succeeds - it would set a valuable precedent in business and supply chain value creation. On the off chance that it doesn’t - it would still be intriguing to learn about the impact of business decisions and feed ones’ curiosity.