ONDC and the Next Digital Commerce Evolution

Digital public goods such as ONDC will expand the market and accelerate inclusion across the value chain

A few weeks back, those of us in attendance at the Exploring Digital Public Goods in the Indian Context session organised by 3one4 Capital got a chance to be privy to a decidedly insightful conversation. Having delivered their talks and presented their slides, the esteemed panellists from ONDC, Beckn Foundation, and EkStep Foundation were fielding questions from the audience. One startup founder, while earnestly supportive of the giant strides India has made in the recent past on account of public technological rails, nevertheless asked, if an ever increasing number of digital goods are publicly provided for, what role is left for entrepreneurs to play?

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It is an interesting question, one that brings into sharp relief an oft-neglected and under-discussed aspect of digital public goods (DPGs). It could be argued that public provisioning of a non-essential good constitutes encroachment into what should have been a preserve of the entrepreneur/private sector. After all, there is little precedent for any other nation’s democratic government building such infrastructure as a public utility.  Over the past few years, the justifiably optimistic fervour surrounding DPGs such as UPI has perhaps obfuscated, or maybe even drowned out, critical issues around the private sector’s fundamental objective to drive cutting-edge innovation and derive market-level profit margins for services built on these rails. But such an argument would be ignoring the reality of the Indian economy.

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To begin with, several large-scale, era-defining global technological innovations and innovation facilitators over the past half a century have either been publicly provisioned or publicly supported through extensive grants, at least during their initial stages of development. Examples include the internet, GPS, jet engines, and touch screens. Government support for these innovations has acted as a force multiplier for private sector participation and allowed for 100x multitude of innovative solutions to subsequently be built on top of them. The same can be said for Aadhar and UPI as well. Sujith Nair, a co-founder at Beckn.org, offered a response along similar lines when answering the question posed earlier. To take his reasoning forward—notwithstanding, of course, the awe-inspiring potential of private innovation—there are wholly understandable causes as to why advancement of such technologies would have had to be disproportionately dependent on public/State support. Extraordinary R&D prerequisites both in terms of monetary and human resources, long-gestation growth cycles, large-scale convergence and coordination imperatives, and massive uncertainties regarding the prospect and robustness of returns would have effectively foreclosed the possibility of a private player owning the entire development cycle of such infrastructure.

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Sure enough, times have changed and generation-defining technological developments are now being undertaken by private entities as well. Venture capital has played an indispensable role in enabling this massive surge in private innovation. But DPGs remain acutely significant for technological advancement due to their ability to compound possibilities for innovation by broadening access to sophisticated digital infrastructure, support knowledge sharing and ideas exchange through open-source and collaborative frameworks, and help build highly scalable common-use utilities that can necessitate buy-in from incumbent stakeholders with varying objectives. They additionally play an outsized role in furthering a myriad of socio-economic objectives including financial inclusion, improved access to healthcare, learning augmentation, and other State priorities.

This piece, however, is less about the merits and desirability of DPGs — on which terrific commentaries exist — and more about an insightfully provocative statement made by Pramod Varma in response to the startup founder’s question. For the uninitiated, Pramod Varma is a co-founder at Beckn Foundation and has additionally served as the chief architect and technology adviser for Aadhar. He is also the architect of various India Stack layers such as eSign, DigiLocker, and UPI.  In other words, he is someone you should listen to on these matters.

After emphasising the sheer scale of opportunity that India offers, and the possibilities for value capture that emerge for private enterprises as DPGs become mainstream, Mr. Varma touched upon the role that DPGs, especially the Open Network for Digital Commerce (ONDC), can play in creating a level playing field for enterprises and encouraging greater innovation by bringing in some semblance of unification. Something like a lingua franca for the digital economy, built on open-source protocols, and interoperable, modular, and scalable architectures. This will surely result in a degree of commoditization, he argued. But such commoditization is imperative. “If we don’t commoditize, your competitors will.” This singular sentence has served as the prompt for this piece. What role, after all, will commoditization play in the digital commerce industry? And how will it impact businesses’ profitability?

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Commoditization refers to the conversion of a business offering or product with unique, distinguishable characteristics, and possibly even elements of proprietary value, to one that is essentially interchangeable with others of the same type. Of late, there has been a growing chorus of concern around businesses’ ability to create and sustain profits when building on, or competing alongside, open-source DPG driven solutions. Much of the brouhaha has been around the UPI and its expected impact on the revenue potential of digital payment applications. The underlying fear is that democratisation and access enabled by DPGs can lead to industry-wide commoditization which could render value creation and product differentiation difficult, if not impossible. This could, in turn, limit margins and stifle growth.

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As mentioned earlier, a certain degree of commoditization is inevitable when businesses start building for the same stakeholders digitally. But does commoditization necessarily lead to attractive profits vanishing across the value chain? Or do they merely shift over time? And should commoditization in a value chain be seen as being diametrically opposed to value chain integration?

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In most value chains, modular and commoditized architectures often simultaneously coexist with more integrated or interdependent ones. Taken together, they constitute a continuum rather than a strict binary. They work in tandem to optimise the weakest link in the chain- the aspects of the product which are as yet not good enough to satisfy consumer demands for improved functionality, low latency, and high reliability. Attractive profits are thus usually contingent on the nature and extent of proprietary value add, attributable to a large degree, of course, to interdependent architectures. Businesses tend to prefer building such architectures in-house, deploying proprietary technologies and expertise with an aim to achieve product differentiation by leveraging their existing competitive advantages. The likes of UPI and ONDC may not give businesses a lot of room for manoeuvrability in this regard by democratising the underlying infrastructure and laying down the technological rails for all to use. But again, does that mean that pursuit of attractive profits will prove to be a mirage? Most certainly not.

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As the remainder of this post will show, DPGs can potentially make proprietary value, and correspondingly the associated profits, shift to a different stage in the value chain but attractive profits are conserved. In fact, the swell of inclusive, and accessible innovation enabled by DPGs such as ONDC will lead to a massive net increase in revenue and profit numbers for the industry at large. This network has a high likelihood of opening floodgates of opportunity for an aspirational class of merchants and service providers who have up until now been denied entry to various rent-seeking, “walled garden” platforms making hay out of India’s astounding digital growth story.  The normative contract for DPGs in India is underpinned by tenets emphasising democratisation, equitable access, promotion of autonomy, sustainable and inclusive wealth creation, and a broadening of the community of beneficiaries of India’s ongoing digital revolution.

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Clayton Christensen—author and former professor most famous for developing the concept of disruptive innovation—has done some of the most fascinating work on how profits shift across a value chain over a period of time. Much of what has been conveyed in this paragraph as well as the previous one come from his book with Michael Raynor, The Innovator’s Solution. He argues that once proprietary, interdependent architectures undergo disintegration and eventually become commoditized—mostly on account of businesses responding to altered consumer preferences for speed, convenience, or lower power usage rather than continued functional improvements—attractive profits do not just disappear, they merely shift to a different stage in the value chain. Christensen christened this the law of conservation of attractive profits: “in the value chain there is a requisite juxtaposition of modular and interdependent architectures, and of reciprocal processes of commoditization and de-commoditization, that exists in order to optimize the performance of what is not good enough. The law states that when modularity and commoditization cause attractive profits to disappear at one stage in the value chain, the opportunity to earn attractive profits with proprietary products will usually emerge at an adjacent stage” (The Innovator’s Solution).

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A few examples should make this clearer. Consider the case of the microprocessor industry. With the onset of the smartphone revolution, consumer, and consequently business, preferences moved away from core processor performance to lower power consuming systems  in order to support the entire gamut of features on modern phones without them running out of charge. While Intel had dominated the pursuit of pure processing power in the PC space by continually pushing boundaries through its integrated architectures, the shift described above necessitated a move away from integrated architectures to more modular and low-power ARM (Advanced RISC Machine) processor-aligned architectures. Intel continues to enjoy a healthy presence in the PC and cloud space,  but Arm Ltd., the company that develops and licenses ARM architectures for companies such as Apple to build on, powers 95% of premium smartphones today and posted record profits in FY21. The microprocessor industry as a whole has undergone multiple instances of commoditization in the past without closing the doors on attainment of attractive profits. The image below illustrates this well.

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                              Source: The Innovator’s Solution. Image taken from onepointmore.com

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Ben Thompson, the author of the popular blog Stratechery, gives several contemporary examples to portray how profits shift in a given value chain once modular and integrated architectures are rejigged. Consider the cases of Airbnb, Uber, and Netflix.

                                                                        Source: Stratechery

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                                                                        Source: Stratechery

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                                                                      Source: Stratechery

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Rearrangement of modular and interdependent architectures is a recurring theme in the tech business landscape. Periods alternating between commoditization and integration dominance are cyclical, endemic, and deeply entrenched in tech value chains. Modular PC hardware designs broke IBM’s hegemony with respect to mainframes. Gradually, Microsoft figured out ways to make software the source of proprietary value, with a particular emphasis on the OS. Open-source software backed by the internet and the early world wide web was able to break the stranglehold of proprietary software. Within a few decades, however, the likes of Google and Meta among others have been able to achieve attractive profits, monopolies even, by creating proprietary value through the harvesting of big data.

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So then, what has the law of conservation of attractive profits got to do with ONDC, or DPGs in general? To understand this, it’s imperative to comprehend what ONDC is and what it seeks to achieve. For reference, ONDC is revolutionising digital commerce in the country by enabling an open network built on non-rivalrous and non-excludable public digital infrastructure using open protocols, and  interoperable yet scalable building blocks. It intends to democratise digital commerce in India by bolstering inclusivity, interoperability, discoverability, and scale. Once implemented, it will allow for consumers and sellers to interact even if they have accounts on different platforms, much like UPI in the case of payments. In a similar vein, it will allow different entities to take up logistics, buyer, or seller side activities for the same transaction. The scope of the associated open network concept goes way beyond retail e-commerce. Productive use cases exist across domains as varied as mobility, logistics, travel and tourism, and even food delivery.

ONDC can be the most seminally disruptive digital initiative in India’s economic history. By unbundling the e-commerce value chain in India, it will - i) onboard thousands of hyperlocal players existing gatekeepers have denied entry to, ii) mitigate concentration risk for both buyers and sellers, iii) allow for portability of trust, and iv) delink platform membership from product and seller discovery. It aims to achieve these objectives by holistically bringing about a “paradigm shift from an operator-driven monolithic platform-centric model, to a facilitator-driven, interoperable decentralized network” (ONDC Strategy Paper). The image below gives an idea of this vision.

                                                                                                Source : ONDC

The unbundling shown in the image above will, in addition to anchoring the positives mentioned in the previous paragraph, undeniably break open platform monopolies and modularise existing integrated e-commerce architectures. The resulting commoditization of complex digital infrastructure should prove to be vital in ensuring equitable access to e-commerce innovation. Legacy players may find their dominant positions under threat. But this will give a fillip to new entrants looking to build on commoditised, interoperable digital rails and establish niche value generating avenues for themselves. ONDC will thus emerge as a catalyst par excellence, enabling a combinatorial explosion of ingenious solutions, encouraging a playground view of innovation, and promoting seamless, “unhindered, free-to-scale ‘flow of value’ that a fair and efficient market should have” (ONDC Strategy Paper).

This should entail a substantial rearrangement of the existing modular and interdependent architectures in the e-commerce value chain. Trust, for instance, is currently maintained and enforced through the integrated architecture developed by the marketplace platform. Even though individual sellers on the marketplace often have their own ratings, end consumers would buy products from a specific marketplace only if it enjoys their good faith. With ONDC allowing for portability of trust, it could be delinked from the platform and integrated directly with the architecture and identity of the seller. A plethora of opportunities for devising customised offerings open up once the entire value chain is unbundled/modularised. Players can curate their specific suite of solutions by handpicking the activities they wish to participate in. Physical kirana stores, online retailers, buyers, service providers, and logistics players can deliver on activities across the value chain depending on their respective competitive advantages. An online direct-to-consumer retailer could offer its previously proprietary method of integrating digital wallets as a solution to other retailers. Specialised payment processing firms could expand their footprint and converse directly with buyers and sellers without worrying about putting in place an entire platform by themselves.

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The image below showcases this dynamic by illustrating the different components of an open network enabled by ONDC and how it will interact with other networks/players. The number of possible permutations for rearrangement of the sort witnessed in Ben Thompson’s charts for Netflix et al. is truly extraordinary.

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                                                                            Source: ONDC

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Through all of this, attractive profits will not vanish for businesses participating in this revolution. Overall, revenues, profits, transaction counts, volume of exchange, and innovation can all increase multifold at the industry level on account of the increased participation and reduced friction facilitated by an open network. To echo Christensen, profits will most likely shift to a different stage in the value chain over a period of time. Where exactly that might be and which solutions and offerings would become the next source of proprietary value might be a little hard to pinpoint with certitude at this stage, but improved user experience; orderly, responsive, and convenient sorting of the catalogue; seamless retrieval and presentation of data across platforms; proficiency in provision of specialised services such as accounting solutions for B2B transactions; furnishing of enhanced features by utilising advanced technology stacks and tools such as  AI/ML; and transparency and higher trust for SME lending could emerge as strong contenders. As one of panellists at 3one4 Capital’s event explained, once access to the pool of buyers, sellers, and products is universalised, the axis of value creation in the digital commerce industry will shift away from “what” utility is delivered to the end consumer to “how”.

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There is another frame of reference for scrutinising ONDC’s relation to attractive profits. DPGs in general, and ONDC in particular, have been designed with an unequivocal normative commitment to ensuring equitable access and helping ecosystem participants repel incumbent monopolistic forces. ONDC has explicitly called out existing marketplaces and their adverse impact on healthy competition- “The rapid growth of these platforms has limited the competitiveness of new sellers coming online except as part of an established end-to-end service provider. Although more platforms can and do come online, the extent of investment required to establish such integrated solutions limits the number of players (ONDC Strategy Paper).” Elsewhere, while discussing concentration and its corresponding facets the same paper states, “the platforms become ‘operators’ within the market and the small and medium businesses lose the choice and freedom of participation at their own will or terms.”

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Numerous instances from the past have made it clear that the mere presence of DPGs is not enough to ward off monopolistic impulses within a given sector. Having an open-source framework surely helps; it is, however, a necessary but not sufficient condition to prevent market capture. Similarly, having multiple actors with varying objectives and interests—a scenario taken for granted in the case of DPGs—cannot by itself ensure optimal provisioning of the good in question. In such a scenario, it becomes increasingly pertinent to consider two other questions in addition to one on the conservation of attractive profits. Firstly, how quickly do attractive profits emerge, or reemerge, once unbundling takes place? And secondly, is the resultant period dominated by open-source, modular architectures durable? In other words, can ONDC successfully stave off monopolisation for long? It would be premature to draw out clear-cut, linear growth trajectories for ONDC or network(s) enabled by it given that its implementation is still at a nascent stage. Regardless, some degree of speculation will not be unwarranted. Several different scenarios can play out, but they can still be mapped out, albeit in a highly simplistic and rather rudimentary manner, along the matrix given below.

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ONDC must be designed and implemented in such a way that its outcomes are compatible with the situation described in the second quadrant. Suitable building blocks are already in place; the use of open protocols and early signs of widespread participation should bode well in this regard. The exact trajectory it takes will undoubtedly depend on a host of factors including continued cooperation from existing players; appropriate alignment of incentives; suitable regulatory provisions and their proper enforcement; ease of understanding and use by end consumers; seamless flow of value and information across the network’s constitutive interfaces; and smooth functioning of common network services such as the regular maintenance of a compatible reputation ledger, common registry etc.

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ONDC has the potential to irreversibly disrupt the digital commerce setup in India by facilitating a momentous transformation of the rules of the game and levelling the playing field. A reasonable degree of initial hesitancy around its functioning and potential impact is natural given the paucity of understanding about the kind of changes it will beget. Yet, efforts must be undertaken to build confidence among e-commerce stakeholders and the community at large. Businesses must be persuaded to recognise the absolutely gargantuan size of the opportunity that an open network backed by ONDC presents.

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To circle back to Christensen again: yes, the locus of the ability to differentiate will shift as new waves of disruption wash over the industry (The Innovator’s Solution). ONDC is indisputably the biggest wave of disruption to digital commerce India is likely to witness in the near future. Businesses would do well to prepare to ride it.

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