Digital Disrupted

Published: Thu, 08/11/2016 - 09:14 Updated: Thu, 08/11/2016 - 12:16

Is the slump in the startup scene a downward spiral or is it just another business cycle?
Abeer Kapoor Delhi 

When e-commerce giant Flipkart’s valuation dropped dramatically by 27 percent from $15 billion to $11 billion in March this year, it sent shockwaves through the entire Indian startup ecosystem. Since then not just has its valuation plummeted further, but so have the reputation and credibility of the much-vaunted digital India on whom the fortunes of the country’s economic growth were riding. Is the disruption ephemeral or long-term? On this important question ride billions of dollars of investment, and the hopes of thousands of young, first-generation entrepreneurs and workers.There are no easy answers. 

Flipkart is one of the brightest stars of the Indian startup scene. Once the poster boy of the young, defiant entrepreneurial spirit in India, it changed the reluctance of the Indian consumer to shop online, and in the process became a verb: “I’ll flipkart it”. Since its stratospheric drop in market valuation, a million problems have come to light and rumours about the company have spread like wildfire. The biggest public relations debacle for Flipkart erupted in May, when the joining date of several campus recruits from the prestigious Indian Institute of Management Ahmedabad (IIM-A) was postponed. The company’s communications team stated that this was due to a routine restructuring process. Many, however, believed that amidst a funding crunch the company was ill-equipped to take expensive campus hires on board. The decision was not without its consequences, though. Many engineering and business schools have actively considered blacklisting Flipkart, and some have gone ahead and demoted it from day zero of placements. Even before the image of the company in the public eye could recover from the bad press, there is news that close to 700-1000 employees whose ‘performance’ has not improved, despite having been put on notice, will be either asked to resign or be handed a pink slip and severance pay. With this news the cat has metaphorically been set amongst the pigeons, who in this case happen to be the employees of and investors in the organisation. 

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It’s not just Flipkart that is haemorrhaging. In fact, the year 2016 has not brought good tidings for many big-ticket startups. Snapdeal, which snapped up $860 million in funding in 2014 (including investment from Jack Ma’s Alibaba group), has had to tighten its belt of late. The company has held talks with several new investors who have refused to invest at its current valuation of $6.5 billion. It may eventually be forced to go for a down round, where investors purchase stocks at a lower valuation. Zomato’s market valuation was also slashed, almost by half, by HSBC. In 2014 the food-tech startup had been valued at $1 billion and as a result had acquired unicorn status. 

Within the first half of 2016 eighteen startups have shut down, as compared to 14 in all of 2015. The amount invested has fallen dramatically; the second quarter of 2016 – which are the months of April, May, and June – has seen a 59% decrease in investment when compared to the same quarter last year. 

Things weren’t Always like this:

It was in 2014 that companies such as Paytm and Flipkart were valued as unicorns. A 20 percent increase in the number of ventures that found funding led to a 400 percent increase in the amount of money that was pumped into the market, taking that amount to a never before seen amount of $5.1 billion. 2015 broke that, by nearly doubling it; $9 billion entered the economy through new entrepreneurs and their technology-based companies. No one could deny that something that resembled a revolution was taking place in India. 


While analysts hope that it is maturing, those within are confident that this is just a business cycle. We’ve seen this before, sectors often play a round robin; today its food-tech, tomorrow it will be health-tech, but there will be a time in the future where e-health-tech returns


Companies received large amounts of funding, and the number of new ventures per annum dramatically increased from 480 in 2011 to a little over 800 in 2015, pushing the total number of tech-based startups to somewhere near 4,200. In numbers, the compound annual growth rate (CAGR) of the startup market has increased at a rate of 75 percent; the ecommerce industry alone had registered at 35 percent. To compare, the entertainment and movie industry is growing at a rate of 10 percent, while the infrastructure industry at 6.5 percent. In actual value of investment brought in to the economy, the growth rate of these new ventures is slightly above 80 percent. 

The Indian startup environment is one of the most exciting places for investment globally, according to a report released in January this year by Grant Thornton, a leading advisory firm. The vastness of it – large consumer spending and the belief that still large swathes remain untapped – promises returns far greater than the amount invested. Many international companies, including investment funds like the US-based Tiger Global and German-based Rocket Internet, have invested in Indian companies and hunger for a bite of the market. 

There was a dramatic increase in the number of companies funded in 2015. While growth in funding increased from $13 million to $1,818 million in the four years between 2010 and 2014, in 2015 the amount of investment skyrocketed in cities like the National Capital Region, which registered a 93% increase in funding between 2014 and 2015. The number of investing firms in India grew from 290 to 490 in a year. New Delhi, Bengaluru, and Mumbai thrived; in fact, Bangalore, the southern city commonly referred to as the Silicon Valley of India, has been included in lists of the top 20 destinations all over the world for startups. 

Projected growth rates predict that India will have 11,500 tech startups by 2020, while 10,000 already exist. The average age of entrepreneurs in the country is 28, which is much lower than in many other parts of the world. There have been promise and excitement, and easy money and ideas available to companies. Newer sectors had emerged as well: health tech, finance-tech and hyperlocal had become words that every graduate understood. Then came the fall. 

Crunch:

What worries analysts is the dramatic turnaround that 2016 has brought. In the blink of an eye the exuberance and prosperity from last year have vanished. The easy money that was available for startups is disappearing. While the number of startups funded is almost the same, if not higher than last year, there is a dramatic fall in the amount of money promised. 

The total amount of money available in the Indian economy seems to have either remained the same or only marginally decreased between last year and now – what has changed is that investments no longer are spread across the market. The big money is only coming into already established companies such as Shopclues, Snapdeal, and OyoRooms, who have the largest shares of the investment pie.

The flaw, however, appears to be in the discount-based model that has taken over the businesses of companies operating in the sectors of transport, logistics, food technology, e-commerce, and travel. Each sector tries to entice the consumer with attractive deals, heavily discounted thanks to external money received. Cheaper is better, and better means more people, but in the long run it isn’t sustainable. The fine balancing act between expanding, hiring, and maintaining one’s clientele is extremely volatile. It is an open secret that the companies offering discounts are hemorrhaging money, bleeding it out. One example of such a model failing beyond belief was the once blue-eyed startup TinyOwl, the food delivery service that crashed and burned. It was the first company that exemplified the problems with this flawed business model. There is no way that the company could continue to function for very long while offering food for that cheap. Adjusting for this sort of problem a correction is being made in Uber’s driver policies as well. After the initial incentives offered they are greeted with a different policy altogether. Gone are the days of large incentives; now they prefer shorter trips over longer ones. More trips equal more money. 


The problem is systemic; the infrastructure and the people are ready. It is just that  with 19 percent internet penetration, the tech boom or revolution that seems to have gripped India is an urban phenomenon, and has not spread to the rest of the country


Discounting backed by a large influx of capital, while it led to an opening up of markets and a change in consumer behaviour, is not a sustainable model. It has already led to several millions in losses. Investors now want to take more control of the business models, numbers, and figures of the companies they invest in. A wariness has set in. This has, naturally, opened a new can of worms. 

While it would be wrong to assume that the market is tanking, the paucity of funding and reluctance on the part of large investors is now fast becoming a cause for worry. The first manifestation of this, according to AnirudhArun, co-founder of the sports-tech outfit Khelfie, is a visible ‘Series A Crunch’ in the market. What this means is that the companies who are on the verge of a boom will have to wait, hold off, and continue with either the seed capital that they would have got, or continue bootstrapping (self-funding). Series A onwards these ventures gain access to capital from Venture Capitalist firms (VC) or Private Equity (PE) firms. However, looking at the numbers for 2015 paints a very different picture; only a select few companies managed to gain Series A funding, and the largest number were either series B or late-stage funded. 

There has been a drop in the amount of money pumped into the market by VC’s and PE’s in the first of half of the year. While many take solace in the number of deals struck, there is a visible change in the ‘investment appetite’ of these firms. In the words of several entrepreneurs, investor firms have had their fingers burned far too many times. Last year, they backed the wrong companies and waited, but nothing happened. Those companies didn’t take off, or break into the competition.


Srishti Handa, co-founder of The Temperamental Chef, which offers heat-and-eat frozen vegetarian snacks minus the
aloo andpaneer, questions the preponderance of food-tech startups, a sector that flourished last year, saying, “How many food delivery services can be funded? You can’t have ten, twenty companies offering the exact same services and expect all to do well.” She attributes this surge in one sector to what is popularly called the ‘me too’ phenomenon that large VC funds follow. These funds are so scared that they might have missed the boom in a particular sector that they will back another instance of the same idea even when the market might not give them the same results. “There can only be a limited number of Zomato’s, Swiggy’s and other such ‘food-tech’ companies; the investors face an issue of ‘FOMO’, or the fear of missing out,” according to Handa. 

There isn’t much diversification in the portfolio of investors in terms of ideas. They like ideas that work, or have worked – an Uber for India, or an eBay for India. E-commerce, for example, because of the boom it offers, has witnessed the largest share of funding every year since 2012. Accounting for up to 25–30 percent of the total investment gained, this overwhelming percentage of market share will also convince younger entrepreneurs to enter that space rather than any other. This process leads investors and entrepreneurs into a vicious cycle of, first. Replicating only models that are proven to work, and in turn stifling innovation, and, second, increasing chances of failure by skewing the demand-supply ratio, as the space within the market is limited. 

Saturation is one of the key reasons why the market has reached where it is now.

However, what have contributed to the overcrowding are low barriers of entry, and quick-rich schemes that entice the risk-taking youth. Prospering, ‘hot’ sectors such as food-tech, e-commerce and logistics have seen both the largest number of entries and also the largest number of failures. 2012–2015 are now regarded as the golden years: everyone was an entrepreneurs with an idea or in search of one; new and old investors entered the market, pushing capital to any sector possible, hoping for a win. This led to a serious demand-supply mismatch, and the market eventually readjusts itself. 

Karthik Vaidyanathan, co-founder of Instalively, a live-streaming application that has got funding from the likes of Google India head RajanAnandan, believes that the financial crunch that the market faces is not a crisis, but in fact a reality check. The excesses witnessed in the past years, of funding anything and everything, are now being confronted. In a conversation with Hardnews he said, “Many people joined the bandwagon of the startup craze for the wrong reasons. They didn’t seek to bring a change. They joined because it became the next logical thing to do; earlier it was the MBA and now it was the startup.” However, the problem goes far deeper. 

The Digital India Error:

In July the World Economic Forum pushed India down to rank 91 globally on its Network Readiness Index (NRI), a standard used to determine how countries fare in terms of Information Communication and Technology (ICT) influencing innovation. The factor determining the drop is the low penetration of the digital in all parts of India. According to the report, only 5.5 people per hundred have access to broadband Internet, and 15 per hundred have access to Internet and mobile. Literacy and awareness are areas that are constant hurdles in India’s snail-speed embrace of digital. 

The problem is systemic; the infrastructure and the people are ready. It is just that  with 19 percent internet penetration, the tech boom or revolution that seems to have gripped India is an urban phenomenon, and has not spread to the rest of the country. While efforts in both policy and action plans reflect a push to move towards the rural, the dominant form of enterprise in rural areas still revolves around the traditional economy, and the number of tech-based startups is non-urban areas is extremely limited. 

Established tech startups too want to move into these areas, but their movement is bound by limitations. In 2015, with the booster injections given to many e-commerce portals, Flipkart, Myntra and others tried to move to an app-only business model. They had to roll back the move, however, because there weren’t enough people with access through smartphones. The boom that is expected to move to Tier II and Tier III cities is slow. The urban economy is getting saturated with only specific sectors booming, and the rural economy isn’t catching up as quickly as expected. The country seems to be moving in the correct direction, egged on by global economic trends, but  there is still a lot left to do..

Two important points then emerge: one is the limited understanding of technology that the market represents, and the second is that the overwhelming discourse of app-based technologies leaves non-tech-based companies in the dark. 

When looking at the future everyone looks westwards to Silicon Valley. However, what enabled the Valley to prosper was an enabling ecosystem as well as the belief in ideas that looked not only at models that work, but also to enable models that could work. However, the discussion of a better environment revolves around questions of the ease of doing business and the lack of it; if this had been a hurdle, innovation would have been stifled at the very onset. “If you want to start a business it’s possible; sure, there are always bureaucratic troubles, but many people aren’t held back,” says VishalGahlaut, co-founder of Noticeboard, a startup in Bangalore. The problem then is not one of being able to do business, but finding trust in a market that has already made up its mind.

“Things are very different here than they are in Silicon Valley; there they actually promote innovation, and there is a deeper understanding of technology that pushes them,” says AnirudhArun, as the phone line crackles. There is a deep resentment in the newer startups, who are trying to move away from established sectors to newer ones. Khelfie, Arun’s startup, attempts to disrupt the sports industry; they plan to help scout and nurture sports talent from the grassroots up, and provide this talent with coaching facilities from all around the country through their application. There are several hurdles that a medium-level startup faces with their technologies. 

Karthik Vaidyanathan believes that the biggest roadblock is the lack of an understanding of technology. Companies and investors who are interested in an idea, or the technology, will not support it to allow the venture to grow or bloom, but instead will try to control the project by buying it out and turning it into a small department in their vertical. According to Vaidyanath, in the US these companies acquire intellectual property rights, but in India they acquire people. 

Robin Jha, the co-founder and CEO of Tpot, a chain of tea-shops in New Delhi, believes that there exists a divide between tech and non-tech when it comes to funding, “Technology is not just about making an app.” Funding only comes when there is traction, according to him, traction for your brand, your product and what you can do. Most challenges that entrepreneurs face is not only finding themselves, but finding the courage to take the risk, finding talent, and also ensuring that they are able to maintain their business models. “Funding is not easy to come by for first generation entrepreneurs,” Jha continues, which is especially used for hiring talent. Many food tech companies have burned through their funding in talent acquisition, Jha believes that one must hire according to your own expectations, rather than someone else's, he admits there is a serious shortage of good people, and those with skills will come at a higher cost. 

Tech or not to tech

There is an overwhelming bias in India towards non-tech-based startups, or offline-based social entrepreneurs. While they might not have the technology to ‘disrupt’, they bring diversification to sectors that are increasingly looking homogenous, seeking to integrate local solutions. The problem, according to startups who do not have presences on  app stores, is that they struggle to get funding, running from pillar to post in the hope that someone will see beyond the overwhelming discourse of tech and discounts. 

Srishti Handa has been bootstrapping her food business for nearly three years now, and is looking for funding. The business, as she admits herself, is niche, but the Temperamental Chef brings a shift in the gastronomic experience of her clients. There is a visible increase and diversification in the eating habits of people, but this amounts to nothing. “See, this is where eating habits are moving towards in the US, and people are eating healthier, looking for alternatives,” she says. “We will only wake up a lot later.” 

The cause behind this unwillingness to invest in these companies, as Saahil Parekh of the urban farming outfit Khetify puts it, is that “there are little or no returns. No one wants to invest in impact ventures; the wait is longer. Currently it’s about now, now, now.” Only a handful of people across country are looking to invest in such social ventures. 

The problem, it seems, is that these companies do not come up with solid business models, but start off as hobbies or do-good activities. They need guidance and mentorship, which again is lacking in the non-tech space. However, this bias is even reflected in government policies, according to Parekh, where the tilt towards technology is most visible. Even in terms of counting, Nirmala Sitharaman at the Startup States Convention in July only counted the tech startups in the country. 

Conclusion:

Unicorns are mythical creatures that are usually staple characters in fairy tales. When a startup attains a market valuation of $1 billion it becomes what, in venture capital terms, is called a ‘unicorn’. Circa 2015, the Indian startup landscape was littered with so many of them that it had begun to look like the Forbidden Forest near Hogwarts. The billion dollar valuation party could not last forever, though.  Bill Gurley, a partner at Benchmark capital and a well-known investor, predicted in March 2015 that the rapid increase in the number of unicorns may presage what he has termed a “risk bubble” that will eventually burst, leaving in its wake what he terms dead unicorns. Gurley’s prophecy may be coming true in India. India’s unicorns may have exhausted the gold-filled pot at the end of the venture capital rainbow. 

The startup environ is surely struggling, moving from one stage to another. While analysts hope that it is maturing, those within are confident that this is just a business cycle. We’ve seen this before, sectors often play a round robin; today its food-tech, tomorrow it will be health-tech, but there will be a time in the future where e-health-tech returns. The amount of money circulating at a macro level in the economy remains the same. Is it just that those markets that were saturated are seeing withdrawals, bad stocks, and other such movements on the part of the investors, who now are moving towards better informed decisions, waiting to make the correct investments at the correct time?

Is the slump in the startup scene a downward spiral or is it just another business cycle?
Abeer Kapoor Delhi 

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This story is from print issue of HardNews