India’s startup ecosystem has been dominated by a long narrative of future optimism. YourStory reported that $13.7 billion was invested in 2017 in Indian startups, across 820 deals. Much of this money has flowed into domestic-focused consumer internet companies like Ola and PayTM.

Historically, India has been a haven for enterprise technology. Starting with the likes of TCS in the 1980s, India’s companies won through labor cost arbitrage. Newer companies focus more on SaaS products than IT consulting services. Freshworks and Zoho are two well known examples. Companies like Browserstack and Postman are perhaps less well known due to their niche of developer tools, but they are building amazing products with clients across the world. India’s enterprise tech companies fly under the radar, but they have achieved a good level of international success.

On the other hand, Indian consumer internet startups haven’t yet taken over the world. For all the talk of Bangalore being a new Silicon Valley, Silicon Valley regularly produces consumer products that take over the world. India, so far, hasn’t.

Can India produce a true consumer internet giant? Can companies like Flipkart actually live up to their lofty expectations in the future? Many people believe so. I do too. But somewhat pessimistically, I think that future is a long way away.

Narratives of the Indian entrepreneurial story are getting increasingly detached from reality. The optimism surrounding the Indian startup ecosystem is predicated on several assumptions of the country’s future growth. Some of these assumptions are very lofty. A lesson I learnt from Jean Baudrillard’s Simulacara and Simulation is that people often believe in collective fictions. As a society, we often create speculative narratives to fit a story that we want to tell about the world. Eventually, we forget the speculative origin of these narratives, and start making assumptions that are based on the narratives. This takes us further away from the true reality.

As an exercise in returning to reality, here are a few checks about where India currently stands.

How big is India’s actual market?

Contrary to popular belief, India is not yet a huge market; at least, not for consumer internet companies.

India’s tremendous population has led to a long standing narrative of India being a large economic market. It is rare to see an article about India without the number 1.3 billion. And yes, 1.3 billion is a massive, massive number of people. That number has gravitas. Surely 1.3 billion people means huge economic opportunity.

This narrative is true to some extent, but it needs to be unpacked and made more specific. Just because India has so many people, doesn’t mean that everyone has consumer internet needs. India supposedly has 480mm internet users, many of whom only came into the internet in the last two years due to Jio. Internet penetration in urban India is 65%, while in rural India it is only 20%. Only 256mm Indians are on Facebook, with a comparable number for WhatsApp. Hard numbers aren’t out yet, but industry forecasts said that 100mm Indians would shop online in 2017. Only 21% of Indian internet users are shopping online.

The rations are much higher in other countries. 74% of American Internet users shop online. For China, the number is 69%. So for all the internet users in India, they aren’t consuming online services.

There are many possible reasons for this. One easy reason to explain is that the other infrastructure to provide internet services hasn’t yet been built, such as digital payments or bank accounts. A second possible reason is that internet entrepreneurs haven’t yet built compelling services for these internet users. Both of these are true to some extent. But there is a third reason, which is that purchasing power is still too low to spend on internet services.

Lack of purchasing power

India remains an extraordinarily poor country, with little money to spend. India’s GDP per capita is a fifth of China’s, and just 3% of the USA’s. As with the previous point, overall statistics hide the granular reality. South India is about as prosperous as South East Asia, but the North and the North East are closer to Sub-Saharan Africa in terms of purchasing power. Uttar Pradesh and Bihar, are amongst the most populated, and also the two poorest.

Consumption of internet services is pretty discretionary; there’s very little yet in the online world that could be classified as consumer essentials. With such low incomes, the amount of discretionary spending by Indian households is extremely low. A consumer is certainly going to buy an air conditioner before subscribing to Netflix. So it is little surprise that the majority of India’s internet services are targeted towards well-off urban India. For one, most of India’s tech entrepreneurs come from this privileged segment. Secondly, this is the only segment of India with any spending power.

Unfortunately, this segment also seems to be the only part of India experiencing the benefits of economic growth. The Economist wrote a detailed report last year about India’s missing middle class, echoing many of the thoughts in this essay. India’s upper income brackets are cornering the benefits of most of the economic growth. So the number of consumers who could make use of internet services isn’t actually growing. The e-commerce market is a good example of this; after growing over 100% in 2014 and 2015, it grew by just 6% in 2016 and 25% in 201

In terms of dollars, companies are making tiny amounts of money in India. But this doesn’t stop Indian startups from raising money, and planning expenses in dollars.

Make rupees, spend dollars!

Startups are much easier to launch today because an entrepreneur can rely on third party services for a lot of software infrastructure. Cloud services like AWS reduce the effort spent to provision and manage servers. Email services like Mailchimp make it easier to contact consumers. Payment integrations like Stripe make it faster to accept money from customers. The problem for Indian companies is that the vast majority of these services are built in the US, and are priced in dollars. So while these services are cheap initially for an American startup, they’re actually quite expensive in rupee terms.

Indian SaaS companies haven’t built out the tools to compete in each of these verticals. Razorpay might able to compete with Stripe. But is any company in India competitive with AWS? Do Zoho apps beat G-Suite? I’d argue that they don’t. So to some extent, Indian companies don’t have a choice. They have to use American services, and have to pay in dollars.

India’s few SaaS companies look abroad for all their revenues. Freshworks’ first client was in Australia. My two favorites, Browserstack and Postman, don’t even have pricing in rupees! In many ways, these companies have become the modern equivalent of TCS, using cost arbitrage in India to produce products for the world. For these companies, since they make money in dollars, spending in dollars is okay.

Consumer companies like Flipkart or Saavn make money in rupees. They really can’t afford to spend in dollars. But they raise money in the form of US dollars, they are valued at American valuations… even newspaper reports report fundraising in USD instead of INR. And so founders end up planning all their expenses in dollars too. Saavn is probably the most egregious of these, maintaining a full team in NYC and Mountain View. This is the reverse of the usual Indian arbitrage, and I can’t imagine how it would ever be profitable to pay American salaries while making money from Indian consumers.

Brain Drain

So buying enterprise software isn’t cheap. On the plus side, the people supposedly still are. Perhaps we get what we pay for though, for high quality talent in India is just as expensive as it is in the US. Maybe this is because of India’s close ties to Silicon Valley, and the relative ease with which India’s best and brightest are able to emigrate.

Devesh Kapur’s fascinating book, The Other One Percent talks about Indians in the US. The data heavy book raises several fascinating statistics about India’s brain drain. Over 90,000 new Indians come to the USA to work annually.

Devesh talks of how India’s exceptional talent is “thrice-filtered” as it comes to the USA. The first filter is those who are able too receive higher education, who were usually filtered by caste or economic class. The second filter is the people within that group who were able to attain high quality technical education. And finally, the third filter was the US immigration system, which set standards for individuals of specific skills. Thus, the talent that made it to the US was truly India’s best and brightest.

India produces roughly 1.5 million engineers a year, depending on who you ask. We’re losing roughly 6% of that to the USA each year. Given the triple filter, it’s a pretty safe assumption that the 6% that we lose is the brightest.

Indian companies have to compete on foreign salaries. Ola’s average product manager salary on Glassdoor is ₹ 22 lakh, or about $33,000. That’s a tremendous amount of money in Indian terms. The exceptional talent is certainly worth that money, but it doesn’t lead to happy balance sheets.

Furthermore, the supply of quality talent is low. India’s exceptional talent is truly exceptional, competitive at a global level. Yet, India’s average talent is of a dismally low standard. Many graduates are unemployable. The country is missing a middle class in both economic and educational terms.

There is still a huge skills deficit in India. The standard of education for most universities is still very low. As of 2014, there were over 92,000 Indian born doctorates in the USA. As Devesh notes in his book:

“We estimate that, controlling for quality, it will take decades for India’s system of higher education to simply match the US stock of India-born doctorate-degree holders in the science and technology disciplines. In short, the stock of Indian intellectual capital in science and technology is overwhelmingly resident in America.

Without good talent, it will always be difficult for India to build world changing companies.

Optimistic narratives, and overwhelming valuations

No investor or entrepreneur is fully blind to these facts of India. So when one asks why people continue to do business in India, the answer always has one bullet pointed towards future potential. The narrative is always one of optimism. “Yes, we have all of these problems – but, if these problems are fixed, look at where India will be in the future!” Without this narrative, any reason to invest or start a company in India disappears.

The influence of the narrative is strong enough to push valuations to unsustainably high levels. Startup valuations are driven by supply & demand for the company’s shares. If a founder can successfully get investors to believe in her rosy vision, there will be tremendous demand for a limited number of shares, and so the valuation of the company will go up. Furthermore, as an ecosystem, there is a lot of money in India chasing very few good investment opportunities. This is driving valuations even higher. As Kartik Hosanagar says in his article:

…an Indian entrepreneur with an idea but no revenue can command a valuation close to $4-5million just based on pedigree. I am surprised when I see such valuations in US startups but to see it in Indian startups is shocking.

Strictly speaking, a stock is worth the discounted value of future cash flows – so when you invest in a stock at a certain price, that price reflects the market’s opinion of how much money the stock will make in the future. At first, this opinion is somewhat qualitative, driven purely by the narrative that the investors have bought into. When hard numbers come in, this optimistic vision is often shattered. A friend of mine remarked that his company’s valuations were much higher when he wasn’t making money. Once revenue started to come in, the sky was no longer the limit. With hard numbers, the reality of Indian purchasing power, and the small market size sets in. The narrative no longer works.

Venture investors are driven by FOMO – the fear of missing out. Imagine if India produces the next Google, and you had a chance to invest in it but didn’t? At the early stages, venture investing is not very quantitative, rigorous, or scientific. It is about judgement calls, where tremendous amounts of biases come into play. The game of raising money for a startup is predicated on entrepreneurs pitching this narrative of where India will be in the future, and investors not wanting to miss out on that rosy vision. So entrepreneurs have to sell this narrative in order to get investors to bite.

At the same time, investors have to sell the narrative too. How else can you sell an acquisition opportunity at those inflated valuations? How else can you drum up support for the next round? The survival of the ecosystem requires the collective belief of everyone involved.

China Envy

Why do we believe in the narrative of Indian consumer growth in the first place? Perhaps India’s narrative is enabled by the fact that China did it. China’s GDP growth rate barely ever dropped below 10% between 1990 and 2008. This lifted millions of people out of poverty, created tremendous economic opportunities, and proportional wealth for the entrepreneurs and investors who took advantage of those opportunities. Imagine missing out on the next Alibaba, or the next Tencent.

Due to population size and geographic proximity, India is constantly compared to China. India constantly aspires for Chinese style economic growth. Yet this growth has costs. China had to build a totalitarian state with little political freedom or human rights to do that. China had to fiercely protect its infant industries. Can India do these things? Does India even want to do these things? That is a macro question for which no entrepreneur is in control of the outcome.

The need for narratives

All startup narratives are detached from reality to some extent. India’s phenomenon isn’t all that different in that regard.

There’s nothing wrong with narratives per se. They help inspire; it is very motivating to work for, or start, a company that could be a part of a transformative change. Indeed, without that narrative, there’s no reason for startups to exist. Most venture funded companies are certainly not produced by economically rational acts. Furthermore, some optimistic narratives do turn out to be true. It’s no good being the boy who called wolf when it was actually a unicorn.

Yet narratives become dangerous when we forget their true nature. When we build layers of assumptions on top of an imagined fiction, we run the risk of waking up one day to a brutal realization of what the reality truly is. Hopefully the Indian startup ecosystem doesn’t forget that it still needs many miracles to live up to the potential that we all have ascribed to it.

Sources of unconscious plagiarism and further reading

Simulacra and Simulation, Jean Baudrillard

This is one of the most influential books I have ever read. It speaks about two concepts – the simulation, which is an imitation of a real world concept. And the simulacra, which an imitation which no longer has an original. The book is 120 pages of extremely dense text, but will change the way you look at the world if you’re able to get through it.

The Other One Percent, Devesh Kapur

Devesh Kapur’s meticulously researched, data driven book, is about Indian migration to the USA. The book analyzes the various waves of Indian migration, and offers reasons for how and why Indians migrated. It explains why Indians in the US are so successful, and often referred to as the “model minority”. It also paints a grim picture of just how bad India’s brain drain is.

Articles:

India’s Missing Middle Class, The Economist

Valuation and spending should be aligned with market size, Kartik Hosanagar for The Economic Times