Tuesday, May 19, 2015

The perpetual motion machine of online business

Sometime back when I was looking for a mobile, I was checking all kind of deals in e-commerce web sites. One such deal was that I get 3000 INR off for a purchase above 25K. I found a person selling his mobile at 28K. That makes my price 25K. The seller has written, please call before purchasing. When I called, the fact I learned is that he is selling it at 28K, he has to give the web-site roughly 1.5K. 
To summarize the statements
Seller gets 26.5K for his phone
I get my phone for 25K
The e-commerce web site gets 1.5K

Difference: 1.5K is paid by the web site to me.

Suddenly I felt, it is like a perpetual motion machine. I can create two accounts, from one I can sell at 28K, from the other I buy at 25K, I get a margin of 1.5K without selling anything. A bit more research showed that, I hear similar stories from call taxi web sites and many other online services. The taxi driver gets money at the rate he has margin. The customer gets it at cheaper rates. I think the driver can call for his own drive and can still make a marginal amount.

The fundamental economics does not apply here. Somewhere something is wrong. The only possibilities I could think of are
  1. The web site uses investors money to create the market
  2. Part of the revenue from the advertisement and exclusive launches were re-distributed. 
  3. There is additional revenue from selling the data (how many people bought a particular product. What age group bought ipad etc) 
If the first one is applied, it will screw the investors big time. A combination of 2 and 3 are possible. In this case the equilibrium may not be achieved easily.
To understand this situation, let us take the product cost of an imaginary item. If the company is big, the marketing team will spend money on learning the buying pattern, age group, brands people choose and their relative pricing. This will feed to the 3rd point for e-commerce site. The marketing team again uses the information from e-commerce sites for price anchoring and exclusive deals. Then again the sites made money. These two cases, generate money without selling a single product.  The dealer pricing from a company for a product
DP(1400 for an MRP 2000 )= manufacturing cost (200)+ market survey cost (100)+ advertisement cost (400)+ Profit margin (700)

Now the e-commerce web site can sell this product at 1400 and still will not loose money since they already got the revenue from this product.  This is a slightly sustainable model, provided the site offers the discount only for first 100 items or a limited period where they can either collect more data which they can sell (eg: big billion day scam)  or they can use it to generate advertisement revenue from a competing brand

One thing for sure: the equilibrium in e-com business is  pretty much complicated (possibly in the higher orders of an equation) with a lot of uncertain parameters.

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