zomato: 3 factors that can make Zomato profitable in the coming years

India’s internet and e-commerce sector has become one of the fastest growing sectors in the country, even in the pandemic-hit economy. India’s startup ecosystem saw 43 companies become unicorns in 2021; more than 30 strange unicorns that have been created until 2020.

However, history suggests that most of these unicorns struggle to survive and only a few thrive. Those that survive have key common characteristics. Below we try to highlight the key among these.

Key characteristics of a successful new age technology company:

In our view, a successful modern technology company can transform industries, achieve scale expansion and make huge profits, all without requiring large capital investments. It typically has most, if not all of the following features:

1) Low capital cost – Google, Airbnb, Facebook, LinkedIn, Uber, etc. share a common feature: they have scalable virtual models that can grow exponentially without any significant additions to their assets. It’s not like a business like

or D-Mart that would require the expansion of land, factories, distribution centers or warehouses.

2) Data – New-era technology companies collect, store, organize and analyze years of user data, enabling them to deliver targeted advertising and personalize the customer experience. The main difference between a customer entering a Walmart supercenter and Amazon’s online store is that Amazon instantly revamps the entire store in a way that suits that customer.

3) Network effects – For most new-age tech companies, the bigger the network, the more valuable the business. While almost all platform companies benefit from a network effect, the quality of the network effect varies between companies.

4) Economies of Scale – Google, Microsoft, and Facebook can increase revenue with minimal variable costs. It costs relatively little to make another copy of Windows 10 or serve another Google or Facebook client. Facebook’s gross margins, for example, reach 80-85%.

In the Indian context, among listed companies, we believe that one of the companies that has the potential to thrive over the next decade is


Zomato – A disruptor in the food sector, while offering a win-win solution
Zomato offered a solution by being the bridge between consumer needs and providing scalability/distribution to industrials (restaurants).

As we all understand, gross margins (excluding RM cost) are very high (around 65%-75%) in the food business, but fixed overheads for restaurateurs also remain heavy. Therefore, for every additional revenue if the restaurant has to share a certain percentage (15%-25%) with the distribution partner like Zomato, it is still a very high markup/contribution on the marginal cost. And from a consumer perspective, access to variety, ease of ordering and delivery are great value propositions at minimal cost compared to the time and logistics costs and hassle the consumer will encounter.

When analyzing a business, we like to focus on 3 key areas – scalability, inherent profitability and quality of management

Zomato, in our opinion, ticks all three boxes above. Below we discuss them in detail.

1. Scalability
Food consumption, at US$607 billion in 2020, constitutes about a quarter of India’s GDP. However, most of these expenses are due to home-cooked meals. Foodservice (or foodservice) currently accounts for only about 8-9% ($56 billion) of the total consumer food market. This is considerably lower compared to the United States and China.

Part 1:


(Source: Zomato DRHP)

The catering market in India is benefiting from a cultural shift towards out-of-home consumption, mainly accelerated by the lack of time, convenience and quality improvement (mainly food taste and temperature in India).

India’s online catering market has grown rapidly, growing 7x (about 50% CAGR) in the past five years to $3.6 billion, but still captures just 6% of the overall pie of $56 billion that Indians spent on eating out in FY20.

We see continued momentum in the online food delivery market, where growth will be driven by tailwinds such as increasing smartphone penetration, demographic profile, rising income level, increase in the share of young people, expansion of the middle class, urbanization, expansion of nuclear families, expansion of working women, etc. Some of the headwinds of the past decade, such as poor infrastructure, unorganized supply chain, food regulations and irregular supply, have been stopped, promoting growth.

Thus, we expect the online restaurant market to be the fastest growing segment in the entire restaurant industry in India and based on industry estimates, we expect that the market size will be around US$11 billion by 2026, implying a CAGR of 21%.

India’s food delivery industry has already seen considerable consolidation over the past two years, with several competitors such as UberEats, Foodpanda, Tinyowl and Scootsy having either acquired or closed their businesses. Swiggy remains a well-funded competitor. We believe these two will deploy cash to grow the food delivery business with a focus on market expansion, not reckless discounting. They will also use this money to explore adjacencies.

We therefore believe that Zomato is well positioned to grow at a healthy pace over the next decade, driven by attractive market opportunities and potential cross-selling and up-selling opportunities by adding other value-added services like grocery delivery in wallet.

2) Inherent profitability
Zomato has been burning money since its existence. However, we believe that all of these investments in marketing and promotions were necessary to accelerate food delivery adoption and category building. Based on the cohort analysis (Exhibit 2) provided by the company in its DRHP, we expect a sharp reduction in promotional and marketing spend as customer loyalty improves.

Part 2:


(Source: Zomato DRHP)

As the market consolidates, Swiggy and Zomato are now focused on improving unit economics through streamlining promotions, introducing delivery charges, operational leverage, and optimizing logistics costs. As can be seen in Table 3 below, Zomato has seen a significant improvement in their unit economy.

Part 3:


(Source: Zomato DRHP, EIML Research)

FY22 contribution margins of 1.7% were significantly lower than the 5.2% achieved in the prior year, as Zomato ramped up investments in Tier II, III, and IV cities, resulting in a compression of contribution margins. Zomato is now present in over 1000 cities and towns in India and out of these, top 300 cities contributed 99% of gross order value and out of these top 300 cities, only 120 cities had a positive contribution.

In Exhibit 4, the company talked about profitability and how the top 2 cities have consistently seen contribution margins above 5% over the past 7 quarters, giving us confidence in the strength of the unit economy of the company’s business model.

Exhibit 4:


(Source: Zomato Q3FY22 earnings press release)

We believe that economies of scale, supplier knowledge, increased bargaining power and the use of electric vehicles will help Zomato reduce delivery and other variable costs, leading to improved contribution margins. (from current levels of 1%), which will allow the company to transform EBITDA and PAT into the lead. to strong free cash flow generation and high returns on invested capital, given the asset-light business model similar to any other platform company.

3) Quality of management
Zomato started as a restaurant review platform in fiscal 2011 and expanded into food delivery in India in fiscal 2015. It further pioneered the concept of restaurant reservation. table in fiscal year 2016 and Zomato Pro in fiscal year 2017. The acquisition of Carthero Technologies in fiscal year 2018 was made to add hyperlocal delivery capabilities. HyperPure was launched in fiscal year 2019. Finally, Uber Eats India business was acquired in fiscal year 2020.

Zomato is one of the few Indian start-ups that managed to pivot its business and thrive in an ultra-competitive environment to eventually become the first new-age start-up to exit with an IPO in India. This says a lot about the quality of management and their execution capabilities.

The Zomato team is led by Founder (also Managing Director and CEO) Deepinder Goyal, who holds an Integrated Masters of Technology in Mathematics and Computer Science from the Indian Institute of Technology, Delhi. Prior to founding Zomato, he worked with Bain and Company.

Long before Zomato became a billion-dollar public company, it was spotted by a lone investor and founder of

, Sanjeev Bikhchandani, who today sits on the board of directors as a non-executive director. Bikhchandani has been instrumental in the success of Zomato, supporting and supporting the founders through good times and bad.

Recently, Deepinder Goyal announced that he will donate all proceeds of his Employee Stock Option Plan (ESOP) worth Rs 700 crore to the Zomato Future Foundation. The Zomato Future Foundation will cover the education of up to two children of all Zomato delivery partners who have been part of the Zomato fleet for more than five years. Initiatives like these give us confidence in the integrity of management and the kind of culture that runs through the company from the top.

In conclusion, we believe that Zomato (having all the characteristics of a new-age technology company) led by good management with strong execution capabilities, aiming to transform the eating habits of India’s large consumer base has a tremendous momentum for high and profitable growth in the years to come.

(Authors Sachin Shah, is Fund Manager, Emkay Investment Managers and Nemish Shah, is Research Analyst, Emkay Investment Managers Limited)

(Disclaimer: The recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)

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