Apart from traditional metrics, such as profits, cash flows and debt, keep an eye on these when you analyse new-age businesses
12-Jul-2021 •Rajan Gulati
The Indian stock market is witnessing the entry of several new-age businesses. From the recent IPOs of IndiaMART, Nazara Technologies to the forthcoming IPOs of Zomato and Paytm - yesterday's startups have now matured to come to public markets. However, these businesses are very different from traditional businesses. In contrast to traditional businesses which are asset-heavy in nature, new-age companies leverage technology and the internet to drive their operations. Many of these companies act as a platform wherein buyers meet sellers. For example, IndiaMART, an e-comm B2B player, does not manufacture a single product but acts as an intermediary. Its job is to facilitate the smooth functioning of a business transaction.
Such businesses could be of several types - a subscription-based business like Zee5; advertisement-cum-subscription like music-streaming apps Gaana, Saavn; or transaction-based like food-delivery app Swiggy. However, there are some critical metrics that are common to all these businesses. Let's analyse these concepts to understand such businesses better:
It refers to a situation wherein the value of a product, service or platform is dependent on the number of buyers, sellers or users who use it. Generally, the higher the number of users, buyers or sellers, the greater the network effect is and the greater is the value created by the offering. Network effects lead to a winner-takes-all scenario. For example, Google today has a market share of more than 90 per cent in the online search business. The addition of each user improves the search results for other users, thereby providing an impenetrable moat to Google.
Owing to network effects, companies offer discounted services at the beginning so as to attract a greater number of users and reach a critical business scale. When Facebook was launched in 2004, it was a free platform and in 2013, when the company reached a critical user base, it ramped up the effort to monetise its user base.
Customer lifetime value (CLV)
CLV is one of the most critical yet difficult metrics to measure. In simple terms, CLV is the total revenue that a business expects to generate from a single customer during the business relation. To understand this, take the example of a subscription-based OTT platform called Getflix. Getflix offers a yearly subscription plan of Rs 1,000. Suppose, on average, a customer stays on Getflix for a period of six years, then the CLV for a single subscriber will be Rs 6,000.
Customer acquisition costs (CAC)
It is the cost of acquiring each new customer. CAC is mainly calculated by dividing sales and promotion expenses by new customers. Various discounts that today's e-comm businesses offer form a part of CAC. Those companies whose customer acquisition costs are greater than the lifetime value of customers could be in great difficulty.
This is a simple yet powerful metric to understand the function of a business. The contribution margin is calculated simply by deducting variable costs per unit from revenues per unit. However, it is important to categorise fixed and variable costs. Fixed costs are the costs that remain the same, no matter how many of your products or services you produce. Some examples include rent and salaries, etc. Platform-based businesses would expect that as the scale of their business grows, their contribution margin would increase, i.e., variable costs would increase at a slower rate than the rate of the growth revenues. The contribution margin for Zomato turned positive in FY21, as the company managed to decrease sales and marketing expenses.
The number of users/subscribers and churn rate
Platform-based businesses tend to highlight the number of users. They report this data in various forms, such as monthly average users, monthly paying users, etc. However, what is even more crucial is to look at the metric called churn rate. Churn rate refers to the customers who cease to use the services of a business. Calculated by dividing the number of customers churned in a period by the number of customers at the beginning of a period, a high churn rate depicts that customers are losing interest in using the company's services.