Continuing from the previous essay on Zomato, this is another opinion of mine that remains controversial. If not controversial, it is iconoclastic to a fairly radical degree. As a business student, we were told about how a few companies will eventually close the gap of losses and eventually make profits down the lane. The word profit & its corresponding equation are elementary. It is a simple arithmetic equation – the difference between expenses & revenues is the income or loss. If revenue is more than the expenditure, that’s a profit & it becomes a loss when that fails to be the case. However, the nature of expenses differs from business to business. When the reality hits the simple arithmetic equation, it gets pushed into a quantum warp. To get to the two numbers that eventually derive the income/loss is not that straightforward.
For a business operation, everything doesn’t happen on cash transactions. That’s the precise reason there’s an allowance to report receivables that one is expecting. There’s a cash flow cycle that affects the float cash available for a business. And cash in the bank is not necessarily profit either. It is in this labyrinth that the Cerberus of accounting turns into the gatekeeper of Hades. The whole of accounting is made to sound complex enough that a layperson prefers to stay away from it. It can get really intimidating. What also doesn’t help is the elitist mentality of the business folk in trying to ensure the language remains pure & esoteric. Complaining aside, I wish to take the task of making sense of the accounting statements & the concepts in the language of the plebs.
Expenses on a business are of two broad types – fixed & variable. What must be made clear in these terms is that fixed expenses are not fixed by an external regulatory body. It is what the business certifies as the fixed expense. The other nuance in the delineation of these two terms is that they are largely a part of the pre-service, industrial economy. They belong to a time when things were produced in factories. Land needed to be bought, production equipment needed to be bought. In such an economy, to produce anything at a competitive price, one needed to seek mass production and therefore, had to resort to large scale production. Now comes a commonly assumed fallacy. We have been led to believe that at scale, costs come down. It almost smacks of the pulpit as if it were a sacred & undeniable fact. Or how old Ben Franklin put it, self-evident truth that costs will come down at scale. This ignores the basic concept of economics of supply & demand. If anything is available in relative abundance, meaning the demand is lower than the supply, it will have to be priced lower than if it was scarce. If the price at which it’s sold is lower, the costs have to be lower for a business to sustain itself. Whenever the costs were higher, such models evaporated & the lower cost models survived. The accurate statement would be to say that in products produced in abundance, those who were able to keep the costs low survived & their ideas proliferated. Cars were hand-assembled as single units before Ford Motor company brought in the assembly line. Ford had the ability to make a significantly higher number of cars than the other makers at the time, and for his business to sustain, his products needed to sell at the same rate or higher rate than the production. For that to happen, with the artificially induced abundance of an automobile, the price had to be low enough for the masses to buy one. Around the time that Ford’s production model took salience in the auto industry in Detroit, time and motion studies were conducted by Frederick Winslow Taylor. His studies show that when there’s minimal movement of the person working, efficiency goes up. therefore, work had to come to the person instead of the person going to the workstation. This is the description of the assembly line model.
Taylor’s time & motion studies suggest that resource agglomeration or concentration of production in an area of land produces higher output, and hence, allocation of all possible resources becomes efficient. This is the premise behind non-current assets a business owns. It is not a self-evident truth that costs come down at scale always. Costs have to come down at scale, or the business doesn’t sustain itself. This too, is not a complete statement. Fixed costs come down at scale because if the efficiency goes up, goods produced go up without a higher usage of resources. Variable costs remain unaffected irrespective of how much scale is achieved. Variable costs have to come down per unit through investments into converting the structure of costs as fixed.
In the case of Zomato, it is a platform company. The fixed cost of setting up the platform pale in comparison to the variable costs. For a delivery, a delivery partner picks up the order from the restaurant or cloud kitchen and brings it to the consumer. At scale, it implies that a lot more partners are needed. This doesn’t go down at scale. It goes on a parallel trend. The cost of setting up the system to handle as many orders as they come is a fixed expense. The rest of the business expenses are variable, excluding overheads. The service is in high demand and it’s clear that the more the demand is, the more the variable costs go up. This is precisely why delivery companies can show transaction level profits, but this fails to show through to the bottom line. Transactional profit is a rejigged way of saying operational income. There are at least a few more deductions on the business to be made before we reach the net income line. This is where all the platform companies shapeshift from dreamy profit-making unicorns to inexistent mythical creatures.
To believe that a platform ecommerce company will somehow turn a profit at scale says only thing – the person saying it doesn’t understand financial accounts. The beauty of the digital tech world is that fixed expenses are reduced greatly. But to not know this would mean anyone can fall for the myth that things fix themselves at scale. Unfortunately, that’s not the reality. It’s the easiest thing for a platform company to report operational profits. The oft-used spiel is that losses have been minimised. I will venture as far to say that they will never be able to say that gains have been maximised. That’s about as fictional as the unicorn.