CFO Leaders: Path To Profitability—The Nykaa And Toppr Way
In the bleakness of a nationwide lockdown, that has shuttered almost all of Indian business, except the production and sale of essential goods, came news of a young(ish) company having raised Rs 100 crore from an existing investor.
Nykaa is one of the two promising companies on this edition of CFO Leaders, alongwith Toppr. Both almost the same vintage, but in very different businesses—beauty and fashion retail versus education—with different paths to profitability.
To be clear, this discussion took place a few months ago. The world has changed since then, India’s economy more so. First the slowdown, then the lockdown. And yet, the conversation with these businesses is illustrative of how young companies have learnt from the errors of startups past—and have been keeping a tight control on capital raise, cash burn and operating metrics.
Maybe, that will help them weather the current storm. Read on.
Also read: CFO Leaders: Do Startups Need CFOs?
Nykaa’s 3-Point Strategy
Founded in 2012 by former investment banker Falguni Nayar, Nykaa did Rs 1,229 crore in revenue in financial year 2018-19, double that of the previous year, while narrowing its loss to Rs 21 crore. In eight years it has built an omnichannel beauty products business and is now diversifying into other fashion verticals. Chief Financial Officer Sachin Parikh says Nykaa did three things right:
- Offer no platform discounts
- Focus on content
- Focus on one financial metric every year
Menaka Doshi: How have you come close to profitability when so many e-commerce companies are busy burning cash. What did you do right?
Sachin Parikh: We focused on sustainable revenue or sustainable business. It is not jargon. Let me put it this way, you talk about discounting in e-commerce, we don’t do discounting from our pocket.
Menaka Doshi: But, surely you have to spend to acquire customers?
Sachin Parikh: That’s marketing spend. I think it goes back to the pillars, what is our key focus. Our key focus is we work with brand partners and we don’t do things that brand partners don’t want us to do.
So, let’s say we have one Nykaa strategy, in between one Nykaa strategy we have thousand micro-level strategies for each brand. Every brand, we sit with every year and decide what is the target for next year and what do they need to do with us next year.
Menaka Doshi: All that is lovely, how do you avoid the big burn?
Sachin Parikh: Don’t discount from your pocket, simple. Let the true customers come to you. Our customers trust us because we do not have a marketplace model. We buy inventory and we sell directly to the customer, and we buy only if the brand works with us.
To give an example, for a couple of years we didn’t have Estee Lauder group, the M.A.C and Bobby Browns on our website. We could have easily bought it from a distributor and sold it on the website, like many people are doing. We did not do that, and eventually when they came online they came online exclusively with us. Why? because they believed and trusted us - that we will do the right thing for the brand which in turn is the right thing for Nykaa and then for our consumers.
Content Is King
Menaka Doshi: You still managed to build an incredible number of visits and engagement?
Sachin Parikh: One pillar is the brand.
An aspect which a lot of people don’t understand - in beauty, the category in which we are playing—content is king— engaging with your consumer. That is the Nykaa Army - the marketing and content army. Our second employee in Nykaa was our Chief Content Officer. She joined before I did in 2012 and she is still with us and creating content on YouTube, digital, email - that’s something we have been doing (well), educating our customers. Don’t buy it because you are getting a discount buy because you need it and you think you will utilise it, that’s what we are focusing on. We heard from Google that 10 percent of all the beauty content in India is from Nykaa.
Menaka Doshi: That’s played a critical role in the path to profitability?
Sachin Parikh: That’s the reason consumers come back. When consumers come back your cohort looks good. Your customer acquisition cost pans out and you pay off in six months and then you get profitable.
One Metric At A Time
Menaka Doshi: As the company grew how did your financial priorities change?
Sachin Parikh: I think it depends on the phase of the business you are in and what you can focus on. (There’s) only so much you can do at a certain period of time and we have very strategically planned every line item in the financials, saying this is the year we are focusing on this and we are going to bring this down to the optimal level if that might be required.
Let’s go below the revenue level and talk about gross margin or your cost of goods sold, then talk about direct variables which is shipping, packaging and freight expenses. Then you get to indirect marketing—Google, Facebook, and then any offline spends that we do, and then last is employee salary, rentals...
If you consider 2015-2016, we focused on gross margin, then we focused on direct variables and improving that, then we focused on marketing. It was not like the focus was not there in all the teams, but as a management team or as a 2-3 people team we were trying to get those (metrics) efficiently right there.
I think depending on the year we have been focusing on (different things). This year (FY20), as you said, debt. It’s not actually debt it’s actually working capital lines from banks. So, it is not technically long-term debt it is more like one-year debt which keeps on rolling over, and this year the focus has been to reduce interest rates. Imagine in this capital environment where people are not getting funding we are now in the market raising funds for debt or raising funds for working capital, at the same time we are trying to reduce interest rates.
Menaka Doshi: How has that exercise been?
Sachin Parikh: We have achieved it. It’s not that we are not achieving it. We are much stronger than what we were before. As I said, last year (FY19) we were Ebitda positive. This year we should be profit-before-tax positive. We are trying to get our unit economics in place. We had that four years ago, we set a plan that fourth year this is how we are going to achieve it and these are the ten things which we need to achieve it and getting those ten things done over four years .
Toppr’s 3-Stage Plan
Toppr founder Zishaan Hayath says the first few years were capital intensive - as the online education service invested in creating curriculum-related content to draw subscribers. The financial numbers indicate revenue traction starting FY18 - with topline growing four times from Rs 6 crore to Rs 25.66 crore - and then to Rs 60 crore in FY19. Yet, the losses have increased too, at Rs just over Rs 94 crore that fiscal.
Menaka Doshi: As the company grew how did your financial priorities change?
Zishaan Hayath: We are a content personalisation platform, you expect users to pay for something that you absolutely cannot touch. These (subscription fees) are not small amounts, these are in replacement for tuition classes or coaching centers. Now you are using a digital product, something that you cannot touch and is not tangible, and still you have to pay fees that are similar to your coaching classes.
So, to get there in the initial phase you have to overload on engineers, product managers, designers to complete the platform. This is pre-revenue and your spends are through the roof so you are spending close to Rs 5-6 crore a month with zero revenue and you have to still keep doing that because your belief is when you start charging you will charge very high gross margins, because it is content and it is close to 85-90 percent gross margins. So, in the initial phase the challenge is to keep committing money to product development. As soon as your revenue comes in they are close to your 90 percent of gross margin but also the sales cost comes in.
Stages 2 & 3
The second phase is your revenue needs to be greater than your sales cost. And in the third phase is your revenue needs to be greater than all the lines C1, C2, C3. I would say, now we are in our third phase where we are profitable at C3 level but not profitable at Ebitda level.
So, that is the journey for us. Overloading on product spends with zero revenues, getting some revenues and beating sales cost and then getting some revenues that beat direct costs, sales costs and other costs.
Capital Allocation, Risk Management
Nykaa picked an omni-channel strategy in the very early days, Parikh says. The company now has 60 stores, all company-owned and company operated.
Sachin Parikh: This category is not about- put the product online and sell. It is also about touch and feel. Women like to touch and feel certain products, they want to see, they want to test the colour. Now we do give some of those features online. We try to create the same experience that you get offline, online. We have 7 percent conversion right now - so out of 100 consumers who come to our site, 7 get converted and buy. So, 93 people still consume, they consume data, they spend 8 minutes on our website or on our app. They consume data and they basically either go buy offline or they may not buy now and come back later.
The idea over here is two-fold. We want them to touch and feel the brand, touch and feel the experience of Nykaa. The second is, we don’t lose them in the whole online-to-offline play, which is why we’ve been omni-channel from day one. It was in 2013 or 2014 that our first store started. We’ve been expanding in the last two years. We are now focusing on the expansion of the offline piece. We technically don’t need money to run the business. We need money to do this retail expansion. That’s where the money is actually going for us.
While an inventory-led model allows control over product quality and consumer experience, it also costs working capital. But the benefits outweigh the cost, Parikh claims.
Sachin Parikh: As a consumer, what do you consume? You consume a Lakmé Kajal, a L’Oréal lipstick, a M.A.C. foundation and a Huda palette. So, let’s say, these are the four brands you consume. You are not buying one brand of everything, you are buying one brand from one category because that is what you prefer. That is something we identified at a very early stage - as consumer behaviour. If you look at it that way, if you are buying four different brands, four different products, you are getting packages from four different locations.
As a consumer, you have to now co-ordinate with someone at home, keep some cash at home four different times for one order. With Nykaa, there is an 80-85 percent chance that you will get one shipment at home. Now, consumers love that. They don’t have to deal with that four different times with the courier boy delivering it at home. That is something that drives the consumer experience. I have got my package, everything came at one go. I don’t have to follow up on when will my Kajal come, when is this thing coming, when is my that coming.
There is cost advantage to it now. Four different shipments are four different freight costs and packaging costs. Now, there is this one shipment, one packaging, one freight cost.
Menaka Doshi: Does that outweigh the working capital that you need when you run your own inventory?
Sachin Parikh: Yes, it does. If you look at it financially, it does significantly.
Menaka Doshi: Can you share numbers?
Sachin Parikh: No, I am not going to share the numbers. The challenge we have to solve for Is working capital, you are right. That is something we’ve been doing since day one. Unlike a lot of e-commerce companies, we have had significant working capital lines from banks. As any financial person would look at it, you maintain a certain debt-equity ratio. Since your weighted average cost of capital is cheaper when you have more debt, or debt to a certain extent to equity raised. If I were to use equity money for my working capital, I would actually be burning a lot more. Which is why, kudos to all the banks, thank you for the support, keep it up.
Menaka Doshi: You recently acquired 20Dresses.com - a styling portal - and now you are entering fashion retail? How did you determine the risks in such an expansion at this stage?
Sachin Parikh: It goes back to the consumer. We have something called as a pop-up on our current website. We used to sell around 6-7 percent as lingerie. So, we realised that consumers are coming to us and saying, what more can you do? I think that’s where the buck stopped at fashion. It is the next logical expansion. Now, coming back to capital allocation, we actually have a business model for each business and every business has its own capital requirem
Content creation is capital intensive and Toppr started with three subjects, two grades and one board.
Math, Physics, Chemisty.
Grades 11 and 12.
The CBSE Board.
And stuck with that till they had a “strong product- market fit,” says Hayath.
Zishaan Hayath: If we acquired a hundred users, 70 of them would have to stay with us in 6 months and 67 would have to stay in the 12th month. So, that attention curve needs to stay flat. So, till we got there, we did not expand to more grades. So, we didn’t spend more on expansion of content area- just the depth of content area. That is one dimension of capital allocation for us. The other dimension is, for this set of content, what modules can you build? So, can you build practice, can you build practice plus tests, can you build practice plus tests plus doubts? Do you build video lectures? Can you do live classes?
Menaka Doshi: Which you have recently introduced.
Zishaan Hayath: Yes, we introduced live classes now as our 5th module in our sixth year. So, we just stuck with two modules - practice and tests - and in our third year, we did doubts. In our fourth year, we did video classes. In our 6th year, we did live classes.
Menaka Doshi: You think you got it right? Or could you have broadened the portfolio?
Zishaan Hayath: I think we absolutely got it right.
Menaka Doshi: You compete with BYJU that has much more content?
Zishaan Hayath: Actually, it’s the reverse. They do just one set of content. They do a massive top of the funnel. They do huge advertising, more people through the funnel. We are a narrow funnel, but our claim is higher retention, more people staying for longer. Also, paying higher than what they pay BYJUs and all of that.
Menaka Doshi: When you decide to expand content, how will you approach it?
Zishaan Hayath: There are two approaches. One is, we stick to our North-Star metric which is time spent per user. So, anything that you launch, needs to add to the time spent per active user. So, there will be some cannibalisation.
Menaka Doshi: What is the average right now?
Zishaan Hayath: Right now, its 120 minutes per daily active user. So, whenever you launch something new, there will be some cannibalisation. It will shrink from the 120 but add to another. So, the overall net should be positive. So, you are thinking about that as one metric. The other metric is of course, does that line make sense? Is it In harmony with the rest of your features, is it similar gross margins? Is it similar customer acquisition cost? For example, I can’t do something which is completely different. I can’t do an offline class because it is not the same margins, not the same experience.
Menaka Doshi: What has the experience of live classes been like so far? 120 minutes has increased to how much?
Zishaan Hayath: So live is tracking about 22 minutes per viewer but with another 5-6 minutes of cannibalisation.
Capital Raise, Equity Dilution
In the last decade, the one critical issue that several young Indian companies have faced is that their promoters gave away too much equity, too fast. Especially, in the e-commerce space where jargon such as GMV ruled the investor roost. Higher Gross Merchandise Value meants a line of investors at the door. To achieve higher GMVs platforms offered higher discounts. To fund that they needed more venture funding. A vicious cycle of that played on till one day many founders realised they had diluted themselves out of control of their companies.
Not any more.
Menaka Doshi: Was this a lesson learnt from startups past?
Zishaan Hayath: I don’t think it was a conscious call, but I think this is a second order effect. The first order effect was - is your revenue run rate similar to the equity capital you raised?
Menaka Doshi: So, you have raised about Rs 400 crore, so far?
Zishaan Hayath: Yes. So basically, we have raised $45 million dollars lifetime, and we are run rating at $25 million. With the capital you raised can you do similar revenue run rates? If you track it at like close to a dollar per dollar, then your dilution will be lower. These guys (pointing to Sachin Parikh, Nykaa) have even higher revenue run rates compared to equity raised. So, (he turns) you are probably tracking at 3:1, and therefore their dilution is even lower.
Menaka Doshi: But the temptation to dilute faster, get more money, grow faster, all of that?
Zishaan Hayath: Stick to natural growth rates.
Menaka Doshi: What is the natural growth rate?
Zishaan Hayath: Where your customer acquisition cost is not insane.
Menaka Doshi: What is insane?
Zishaan Hayath: If your first order is higher than your customer acquisition cost.
Menaka Doshi: Please explain that
Zishaan Hayath: If your first revenue from that order of your first customer is higher than your customer acquisition cost, then that’s not insane. So basically, we are creating a natural growth rate, right? You are then able to add more money on customer acquisition and get more revenue. For every rupee that I earn, if I spend Rs 3 for customer acquisition cost, I will grow very fast. That is not the natural growth rate.
Menaka Doshi: These are learnings from the fact that customer acquisition costs and all of this were dominant conversations when it came to excessive fund raising over the last decade or so, right?
Zishaan Hayath: Were they dominant conversations?
Menaka Doshi: Were they not? Many large young companies, their founders have been virtually diluted out.
Zishaan Hayath: And we all learn from that, right?
Menaka Doshi: So, it is a learning point. You are cautious about not being in the same place?
Zishaan Hayath: Yes.
Menaka Doshi: Your company has raised only Rs 350 crore (Now Rs 450 crore) so far. You said something really interesting before we started recording this show. That you didn’t really need to raise it, but you did.
Sachin Parikh: It is not like we didn’t need to raise it. We needed to raise it for capex expansion. However, what drives us right now is basically bank debt. We need it for working capital, we need it for bank covenants. So that’s where the capital requirements are coming from. Operationally, as I mentioned earlier, we don’t need the money. Operationally, we can run the business as we are running it right now. So operationally, we are capital positive. Capex we need to burn money for.
Menaka Doshi: So, you raised this for capex?
Sachin Parikh: Yes, we raised it for capex. It’s for more retail stores, we are planning to open 200 stores in the next 2 to 3 years.
Menaka Doshi: And for the fashion vertical and other things that you might choose to invest in?
Sachin Parikh: Yes, for fashion we’d be expanding too. So, it’s also going to go into that.
Menaka Doshi: So, this Rs 350 crore will mostly do it for you?
Sachin Parikh: Rs 350 crore is over the lifetime. We raised it early this year and I think that should be sufficient for a good period of time. However, there are a lot of other reasons why you raise money, not necessarily just to burn.
Menaka Doshi: Talk me through your approach
Sachin Parikh: I think what we have done differently, we don’t raise for 3 to 4 years hence. What a lot of founders, what a lot of entrepreneurs have done, they dilute 30 percent, they raise a lot of money. They say okay this what I am going to spend over the next three years and they spend it on the one year, and they come back saying I spent it on one year, I need more money.
Menaka Doshi: You stagger the expenditure and hence fund raise? For better valuations?
Sachin Parikh: We stagger it every 1.5 year. We stagger it that way, so we get a better valuation because the business has grown. But then (we have to) be a little more cost conscious, because now we know we have only so much money and we can’t spend so much. We need to control it. So, it puts a natural control on all of us as well. So that is something we have been doing differently that anyone else.
Menaka Doshi: Self-imposed discipline.
Sachin Parikh: Correct, and to what Zeeshan is saying, he is right. We have raised Rs 350 crore - most of what has gone into loss funding, operational burn and half of it has actually gone into capex. So technically, if you look at it, I have spent $30 million till date. We are right now on a $300 million run rate. So 10x to what we have raised. Unlike any other company – which is usually around 1 or 1.5x. We have been doing things differently, partly because we have been controlling costs and all of it.
Watch | Sachin Parikh and Zishaan Hayath in conversation with several young startup founders and funders.
- Anirudh Pandita, Founder, Pocket Aces
- Naiyya Saggi , Founder, Baby Chakra
- Aakrit Vaish, Co-Founder & CEO, Haptik
- Rohit Pugalia, Partner and CEO, Soch Foods
- Sidd Gandhi, Founder, KyePot
- Deekshith Marla, Founder and CTO, Arya.ai
- Munaf Kapadia, Chief Eating Officer, The Bohri Kitchen
- Armaan Vananchal, Co-founder, Frapp India
- Rajiv Suri, Partner, Orios
- Anil Joshi, Founder and Managing Partner, Unicorn India Venture