The show stopper, in the month gone by, was the spectacular launch of Reliance Jio, rattling the telecom industry and consumers alike. While a disruptive pricing was by-and-large expected with the Jio launch, the actual announcements in the AGM; free voice calls, cheap 4G data rates, cheaper 4G devices and unrestricted Internet access, surprised and spelt further trouble for the incumbents. Stocks of Bharti Airtel as well as Idea Cellular plunged. While investors thronged the counter in a bid to offload their holdings, consumers made a bee-line to the outlets to lay their hands on the sim!
Weren’t ‘Idea’ and ‘Airtel’ supposed to be brands and hence trading at premium multiples? Or should we rather have looked at them as ‘branded commodities’, deserving lower multiples in reality?
A commoditised business exhibits some typical characteristics – high asset intensity, low brand loyalty, competitive pricing environment (inability to raise pricing) & non-differentiating service offerings (amongst others). There is always some company that suddenly comes up with a business model that’s more competitive, translating into reduced pricing and narrowing margins for the players in the industry. This endless commodification cycle builds companies up and takes them out at a ferocious pace. Retaining the customer proves to be a serious challenge. In most cases, the end consumer stands to benefit by way of improved offerings and lower wallet spend while the pain is borne by the companies (and investors alike). Other than the type-casted ‘commodity industries’ like metals, sugar, textiles etc, this has been witnessed in some other industries as well, resulting in a reduced band of multiple that several players in the industry have started trading at.
- Airlines – companies operating in this industry have never/rarely generated returns, despite huge tailwinds and strong air traffic in the last few years.
- Software services – many parts of the business get increasingly commoditised over the last few years, resulting in margin pressures for companies, despite volume growth.
This is probably what the telecom industry in India is/has been also witnessing. While these ‘brands’ have been investing heavily over the last few years to improve their service offerings and build customer loyalty, ground observations prove otherwise much to the dismay of the players. After all, the average Indian consumer has historically demonstrated his loyalty only to ‘price’, while being demanding on quality parameters at the same time.
I do not intend portraying the demise of any company or industry, from a business standpoint. There are large companies having a proven track record of surviving across cycles by reinventing themselves. They may continue doing so. The dominant Indian telecom companies, for instance, are well managed businesses generating significant cash flow from their operations and are expected to respond appropriately to the pricing trend initiated by Jio. However, the constant strain put on the estimated cash flows on account of unforeseen competitive pressures is what should keep their valuations under check. We are in a day and age where technology is proving to be disruptive, not only for traditional businesses but also new age businesses. Acknowledging that businesses, erstwhile strong, are also prone to commodification could help us remain vigilant and avoid any significant investment heart burns.
Is there any other industry which, in your opinion, is witnessing / expected to witness commodification? I would love to hear from you.