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ONDC - Another Blow to Companies Betting on Network Effects?

ONDC - Another Blow to Companies Betting on Network Effects_
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Author: Balkrushna Vaghasia

Is it feasible to picture a life without Whats App? No, right. Have you ever pondered why we've grown so hooked to the system?

I know what you're thinking: who wouldn't be captivated by Whats App? It is, after all, Whats App. But, as the saying goes, everything exists for a reason.

So, let's figure out why we're so hooked by delving into what lead us to become a part of the Whats App ecosystem.

This is due to Network Effects. How do we fit within this network effect? So, in a nutshell, we are the network's nodes, and the links are the connections that we, as nodes, create either individually or collectively as group nodes.

The network effects system operates in a logical fashion. Assume you've joined Whats App. You and three of your friends are connected via Whats App in the way depicted.

Assume you've added one additional buddy to your group. That one friend is now Whats App friends with all four of you. Now, this is how the network looks like.

As you can see, even when only one person is added to the network, the number of linkages increases substantially (from 6 to 10). So, in essence, a network effect arises when one user increases the value of a service for other users. When new users join the network, they boost the network's value by connecting with current members. It is tough to leave the network after you have become a part of it and formed strong relationships with the nodes.

Each time a user utilises the company's product, it increases the stickiness to the network and also the value of the network. Further, as the number of users grows, both new and current users do not find much value in joining the competitor's smaller network.

Not just Whats App, but also Instagram, Google, and Amazon have created virtual networks. Each entity's network works in a different way, but they all end up building highly defensible ones that are tough to quit. There are a few physical networks as well, such as roadways. Roads constitute a network in which the individuals who use them are nodes and the roads through which they connect the destinations are links. There are a myriad of benefits for which firms develop these networks.

How Companies Benefit From Network Effects?

Let's take Amazon as an example to understand. It created a marketplace for buyers and sellers to interact in. Initially, Amazon offered enormous discounts on its platforms to entice people to buy from it, with the convenience of having the things delivered without stepping out of the door. It organises events such as ‘The Big Billion Day’ and ‘Independence Day Sales’ to draw the attention of users. It lured sellers by providing a platform for them to offer their products to buyers located far from their region of operations, thereby extending their customer base. Sellers were also given logistical support, so they were expected to continue selling their products as they had been selling to local buyers, while simultaneously reaping the benefits of a larger consumer base. These benefits had a propensity to swiftly expand the number of sellers on the site. Now when a large number of sellers have entered, the number of buyers would increase as they would receive more options in the network. This chicken egg problem is the reason that the entire loop of network effects are created by companies.

Individual nodes, such as buyers and sellers, do not have the choice to join another network once a company has developed a giant network of nodes because they will not be able to find a big enough pool of sellers and buyers respectively for their products. As a result, both customers and providers are now stuck. If new users who have never used the network wish to trade with existing users of the network, they must first join the network.

Furthermore, the network owner may readily imitate an entrant's incrementally enticing innovation and induct it into the company's network. The reel feature, for example, was introduced by Instagram to protect its network from the competition created by Tiktok.

Also, a broad observation can be made by analysing the profits of all internet companies that came since early 1990. Majority of the cumulative profits earned by internet companies has been captured by the companies whose business model is based on networks. The more dense the network, the higher the durability of the competitive advantage. Therefore, the new age internet companies are trying to build networks.

What is Open Network For Digital Commerce (ONDC)?

In order to better grasp ONDC, we must first examine UPI technology.

Before the launch of Unified Payment Interface (UPI) in 2016, there were a handful of wallets in the payment network business. Paytm was a dominant player among them. In the pre-UPI era, users of one wallet were not able to transfer money to another wallet, just like you cannot send a message from Whats App to Telegram.

UPI is an open source protocol using which wallet companies can facilitate money transfers. UPI enabled the transfer of money from one wallet to another at almost zero cost. This laid the foundation for an expanded, efficient, and low cost network for payments.

ONDC, like UPI, will be an open network that provides protocols to allow free flow of digital commerce across various categories such as groceries, electronics, books, food, etc. It will establish standards for all network participants, including merchants, e-commerce platforms, and delivery partners.

ONDC is expected to democratise e-commerce in India. Currently, anytime a seller joins an e-commerce site, he/she must go through a separate KYC procedure. For onboarding sellers, each platform has its own paperwork and procedures. Once the ONDC provides the protocols, a seller will only need to go through the onboarding process once and will be able to sell items on all e-commerce platforms, such as Flipkart, Amazon and Zomato. Even the smallest mom-and-pop Kirana stores will be able to sell things digitally owing to ONDC.

Why do I think existing e-commerce companies will face the heat?

Let's take a look at what the government has to say about ONDC. After listening to a few senior bureaucrats, it appears that the government is dissatisfied with certain policies and practices of the existing platforms. For example, E-commerce aggregator companies are selling their own products on the platforms they manage. They are suspected of manipulating product display on the platform by prioritizing their own products or products of their affiliates. Another source of dissatisfaction is the hefty fees that these sites charge vendors.

The Indian government claims that ONDC would only broaden the market and that it does not wish to compete with existing firms. However, a careful scrutiny of the remarks made by some of the top bureaucrats, R S Sharma, CEO of National Health Authority and Anil Agrawal, Additional secretary, DPIIT, at a panel discussion organised by Economic Times on 12th March 2022 reveals that the Indian government wants to end the monopoly (current or even a potential monopoly). So it's hardly rocket science to see how this action may be a death blow to firms dreaming of being a monopoly. One of the most significant effects will be on startup valuations, which are dependent on the value that these firms will capture once they have successfully built a network.

The network effects that these firms have developed might be jeopardised since ONDC will offer a common platform for buyers and sellers, and buyers and sellers will no longer be restricted to a single platform. A simpler way to describe this is that, owing to ONDC, an Amazon seller may now sell their items to a Flipkart buyer. Also, a new seller is discoverable to buyers across platforms.

In the End…..

We witnessed in the case of Payments that the open source nature of UPI was the reason for entry of significant players like PhonePe and GooglePay, which ended the monopoly of the first mover, Paytm. ONDC has a good potential of disrupting the moat of the powerful ecommerce companies in the same way that UPI did for payments. Thus, ONDC will have a significant detrimental influence on the future profitability and values of these existing e-commerce platforms. Existing e-commerce platforms will obviously grow, but their share of the total pie will not be as big as they hoped earlier.

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