Once upon a time, Nykaa was considered a shining outlier amongst a sea of loss-ridden tech companies.
Having listed in 2021 as a (rare) profitable tech company and the dominating category creator of the online beauty and personal care (BPC) market in India, its shares had debuted with an ~ 80 percent premium.
But since then, its shares have been on a downward spiral and have settled at a ~60 percent mark-down – a literal mirror image of its bottom line, which has declined ~60 percent since its listing, to a meager profit of ~ INR 25 crore.
On the other hand, Nykaa’s topline has more than doubled in the same period to ~INR 5,200 crore, while EBITDA has fluctuated around a bit.
What’s the narrative behind this confusing array of numbers?
Essentially, a business model in flux. For years, Nykaa has been trying to diversify multiple facets of its business – how it sells, what it sells, and to whom it sells – all at the same time.
A risky endeavor, at the best of times. A very bold endeavor, when your profit margin, at its best, was at 2.5 percent.
Let’s take a look at what’s happening.
BPC Remains Nykaa’s Cash Queen
Nykaa’s role in revolutionizing the online BPC space in India is a story that is well known, and I don’t want to be accused of wasting one’s time when playing in this attention-deficit economy. Here is a brief AJVC primer to catch you up to speed.
To cut a long story short, the poor bottom-line numbers we saw earlier mask a nicely maturing business, that is Nykaa’s BPC vertical. After cutting down on operational expenses, BPC’s contribution margins stand at a whopping ~24 percent of its revenue (up from ~19 percent last year).
Digging a level deeper is tricky, as Nykaa has not provided segment-specific employee expenses or EBITDAs for FY23.
But a handy bit of extrapolation from previous years’ numbers gives us a neat segment EBITDA margin of 10% (up from ~8.5 percent last year). Brokerage reports expect this margin to go up to ~15 percent by FY25, on the back of sustained decreases in fulfillment, marketing & advertisement expenses.
Not exactly phenomenal, but not woeful by any means either. And a series of interesting bets made along the way could make this segment even more lucrative.
The first bet – brands. Nykaa now owns 13 BPC brands, which cumulatively contribute ~12 percent to its BPC gross merchandise value (GMV). Further scale would provide upward pressure on the segment’s BPC’s profit margins.
The second bet – stores. It has set up 145 physical stores (up from 104 last year), which contribute ~9 percent towards BPC’s GMV. While this seems an odd step for an online retailer, these stores are meant to act as a funnel for its online business, by allowing new customers to experience Nykaa’s brand¸ and/or old customers to try new product offerings. The icing on the cake – the stores were profitable in FY 23.
And the final bet – shifting from a national to a regional fulfillment structure, which is already paying off in terms of reduced fulfillment costs. Within a span of one year, Nykaa has increased its fulfillment centers by ~50 percent, in terms of both numbers (25 to 38) and area (8 to 1.4 lakh sq. ft.)
Together, these three bets explain a major portion of the divergence between Nykaa’s EBITDA and PAT margins – financing, depreciation, and amortization costs have all risen to reflect the above investments, thereby depressing PAT.
Well, that answers for falling PAT. But even Nykaa’s EBIDTA margins seem to be struggling. And like with PAT, the answer lies in the way Nykaa is changing what and how it sells.
The story goes back to 2018. Having established itself as the dominating force in the online BPC space in India and set itself on a path to profitability, Nykaa was searching for its next driver of growth.
It set its sights on fashion – an addressable market more than three times the size of BPC’s.
Fashion Struggles to Fit
Nykaa decided to do things a little differently. With BPC, Nykaa had followed a pipeline model – it essentially bought inventory and sold its stock as an online retailer, allowing proper quality control and plugging the industry-wide vulnerability of counterfeit products.
With fashion, given the larger number of SKUs involved, it decided to become a true platform – a marketplace for buyers and sellers. Accounting for six out of the ten most valuable companies in the world, platform businesses have long been considered as the ‘ultimate’ business models.
A large addressable market. A fast-growing customer base to cross-sell to. And a platform business model. Nykaa believed it had all the ingredients to make fashion its new success story.
Five years on, fashion is proving to be a tough nut to crack. This segment accounts for less than 8.5 percent of Nykaa’s revenue portfolio and has managed to capture just 10 percent of the online apparel space.
And growth seems to be slowing down. In FY 23, the fashion segment’s revenue growth barely exceeded the beauty and personal care’s (BPC) growth, and orders actually grew at a slower rate – despite the latter’s much larger base, and smaller addressable market.
GMV’s growth rate has been on a downward trajectory for the past few quarters, barring a sharp uptick in the last quarter. Nykaa attributes this sluggish growth to muted discretionary demand by consumers – which, to an extent, is true.
But Nykaa faces more intrinsic, and somewhat intuitive, challenges in this space.
From creating a category in online BPC, Nykaa is now competing against the category creator in the online apparel space – Myntra (Flipkart) – which currently dominates 50 percent of the market share. The presence of other deep-pocketed behemoths, like Reliance’s Ajio, Amazon, and Tata Cliq, is making online fashion a highly competitive playground.
Apparel may not be a natural cross-selling opportunity for Nykaa. With BPC products, once consumers have established affinities for specific brands and products through trial and error, they often repeat their purchases periodically – quite well suited for an online channel.
With apparel, however, specific products are rarely repeated, and consumers rely a lot more on touch, feel and trials for every purchase – therefore more suited for physical channels.
Data backs up this intuition. Currently 75 percent of BPC’s gross merchandise value is sourced from repeat customers. For fashion, this metric stands at 35 percent, albeit up from 13 percent the previous year.
Reluctance to purchase apparel online would increase even more for premium-priced products. But the premium is where Nykaa Fashion seeks to differentiate itself from its deep-pocketed competitors – its average order value is ~INR 4,000 (up from ~INR 3,100 in 2021). On the other hand, market leader Myntra’s average order value is INR 1,400.
Convincing customers to buy premium fashion online may be Nykaa’s Achilles heel.
Part of Nykaa’s solution to these challenges is to throw money at the problem – almost ~40 percent of Nykaa’s total marketing expenditure is allocated to fashion, despite it bringing in less than one-tenth of its revenues.
Consequentially, the fashion segment spends almost half of what it earns just to market itself, whereas BPC spends just 8%.
Interestingly, Nykaa believes that as fashion’s “mix of new customer to repeat customer ratio improves, marketing cost” will come down – which brings us to the second challenge highlighted earlier. And while fashion’s repeat customer rate has more than doubled in a year, marketing expenditure as a proportion of revenue has remained the same.
Contribution profit and EBIDTA have actually worsened year on year – both in absolute as well as margin terms.
For now, Nykaa’s play to change what it sells is eating into its overall EBIDTA margins.
TAM, TAM Everywhere
Nykaa is not only changing what and how it sells. It is also changing who it sells to. And like with fashion, it seems to be keen to experiment in the hopes of cracking bigger markets to serve.
Historically, BPC has been primarily a women-focused product segment, and therefore Nykaa has been a brand strongly associated with the female consumer. But male grooming is turning out to be an expectations-defying emerging industry.
While Nykaa did obtain an early foothold in this market in 2018 by launching a male product-focused website, the results seem to be quite muted, given the absolute lack of real estate this segment receives in Nykaa’s annual statements and investor presentations.
What may be a bit more interesting, is Nykaa’s new direct-to-retail application – Super Store – seeking to tap into the offline BPC segment by connecting retailers directly to manufacturers, allowing the former to source cheaper supplies by skipping distributors and wholesalers.
Launched in 2022, Super Store shows promise. In just a year, transacting retailers have grown by ~500 percent, from 20,000 to 100,000 and the number of orders placed has grown by 1,500 percent, from ~50,000 to 7.2 lakh. If scaled successfully, the application could unlock lucrative monetization opportunities through value-add services like merchant credit, bill invoicing, data monetization, and so on.
These experiments yield interesting possibilities, especially since they are within Nykaa’s proven area of expertise – BPC.
But experiments cost money, and these ones further depress Nykaa’s EBITDA by ~INR 100 crore.
If fashion does not turn profitable soon, Nykaa may soon be faced with a battle of choices. Compromise on its ability to build its BPC offerings, through owned brands, physical stores, regionalized distribution, male products, and direct-to-retail, while letting fashion bleed its bottom line with an uncertain path to profitability. Or kill fashion, lest it kills Nykaa.
Writing & Design: Shreyas Vatsayan