Source: economist.com, April 25th 2012, by A.A.K., Mumbai

NINJUU NARANG, a middle-aged cloth manufacturer and wholesaler from Gujarat, is in a cheerful mood. Last month he sold saris worth $20,000 in just 10 days on Snapdeal.com, a Bangalore-based daily-deal and e-commerce portal. Every morning he wakes up to a consolidated list of customer orders in an e-mail from Snapdeal. Later that night the consignment is dispatched in a truck which trundles along for one-and-a-half days, covering over 1,000km (about 600 miles) before reaching Snapdeal’s warehouse in Gurgaon, a flourishing industrial belt in North India. From here the saris are couriered to consumers across the country. Snapdeal earns a hefty commission on such deals and Mr Narang now sells to scores of customers he has never met, a first in his family’s three decades in the trade.

Selling online has not always been this easy. In 1999 K Vaitheeswaran founded Fabmart.com (now IndiaPlaza), India’s first e-commerce site. Back then only a small fraction of the 3m internet users transacted online. Halting dial-up connections and text-only browsing were not cut out for navigating complex payment gateways. Few Indians held credit cards and fewer still were keen on disclosing their card details. Nowadays more than 100m surf the web. Close to 30m scour for bargains online, and the number which grows by 1.5m every month. The industry is worth around $10 billion, though travel-ticket sales alone accounted for $8.4 billion last year.

Little wonder, then, that in 2011 investors ploughed more than $450m into Indian e-commerce. Flipkart, India’s largest online store by revenue has so far raised $31m since it was founded in 2007 and employs more than 5,000 people. With average daily sales of $500,000, the company aims to hit $1 billion by 2014-15. Last December Ambareesh Murty, an erstwhile e-Bay executive, used a seed fund of $5m to launch Pepperfry.com, which sells lifestyle products. In February Amazon debuted in India through Junglee.com, a product-comparison website which aggregates information from different e-commerce sites. In just two years Snapdeal’s venture-capital (VC) backers have stumped up $52m. Myntra, a popular seller of fashion products, has managed to tap investors for $40m since its launch in 2007.

It is only natural that the industry should flourish. Indians are young—almost half of them are under 25—and growing richer. Its income per capita has risen by 12% between 2008 and 2011, to $1,500. The International Monetary Fund reckons it will reach $2,300 by 2016. With more money to spend, city-dwellers lap up online discounts. Nor is the trend confined to the biggest urban centres. Roughly a third of all products sold online are shipped to cities with population of 3m or less. Many of them lack supermarkets and other big retailers. The internet offers better deals and a wider variety of goods to choose from.

There are problems. “Inventory based e-commerce in India is extremely capital inefficient,” says Avnish Bajaj, boss of Matrix partners, a VC firm. According to his calculations, in India, stocking inventory for 60 to 90 days with an annual sales target of $200m requires working capital of about $40m-50m. Banks are reluctant to lend to companies with untested business models, so almost all of it is being financed by fickle equity.

Revenue models look shaky. To secure repeat business, most portals offer incredibly low prices, payment by cash on delivery and, nearly always, free shipping. Consumers love it but companies are scratching around for ways to shed the operational burden. Ironically, the very things that have propelled e-commerce in India could lead to its downfall. When Mahesh Murthy, the boss of Pinstorm, a digital marketing firm, and investor in a few e-commerce companies, purchased a mobile phone online recently, he discovered two invoices in the parcel: one for 28,000 rupees ($530), which is what he paid, and another for 30,500 rupees, which is what the seller apparently paid to his supplier. Such price competition takes its toll. One firm, taggle.com, shut up shop in December citing its unwillingness to “burn a lot of investor money” to outlast rivals.

Companies that do best have diversified and focused on customer support. Last month Flipkart struck deals with record labels and introduced a digital-music store which offers songs in over 55 languages. A dedicated customer-service team trawls social networks and consumer forums to address complaints. The company only offers free shipping for purchases exceeding 200 rupees, something Western online sellers do routinely. It was also the first to introduce a 30-day replacement guarantee on all products. “We don’t compete on price,” says Binny Bansal, the company’s co-founder.

Competition is fierce, but there are already signs of consolidation. In February Flipkart bought Letsbuy, a rival firm, for $20m. On April 3rd Snapdeal acquired Esportsbuy.com, an online retailer of sports and fitness equipment, reportedly for between $10m and $15m. There is certainly room for growth. E-commerce accounts for just 0.12% of all retail sales in India, compared with over 4% in China and America. But expect growing pains. Even Flipkart, arguably the most successful online retailer, has yet to turn a profit.