And what can India to do fix it
According to the World Population Review, India is ranked as the third highest country in terms of unicorns (71 in total) with companies like Flipkart, PhonePe, Dream11, & CRED becoming household names and sponsoring the Indian Premier League (the largest professional T20 cricket league in the world). Yet, behind the gloss of the startup world in India, what we don’t realize is the dark reality for the rest that don’t make it to their IPO.
A study by the IBM Institute for Business Value and Oxford Economics in 2018 states that 90% of Indian startups fail within the first 5 years of their existence. And even if the startup survives, they face the prospect of slim margins, low profitability, constant nudges from VCs to grow at an unsustainable rate, which eventually leads even more companies to crash out and burn in the long run, taking down the livelihoods of thousands of employees in the process. In fact, only 15% of all startups are profitable in India, which explains why the startup world fires 1600 people a day (on average, according to 2023 figures).
Even more disturbingly, according to most news outlets (including CNBC), India ranks consistently as one of the worst countries in the world to get a business or a startup running. According to the World Bank’s Doing Business archive, India’s rank in ease of doing business is 63rd, lower than Rwanda, Beb a long way to go in terms of making a more conducive environment for our startups.
Why is the entire system like, and how did we even get here?
There are four reasons as to why many Indian startups failed especially during the last half of the previous decade, one of which was a short-term problem and other of which is a structural problem in the mindset of Indian entrepreneurs:
The first issue that caused many startups to crash and burn in India especially during the pandemic and its aftermath is the amount of unsustainable debt in the form of investments and other loans that Indian startups took on during the early 20s.
During the pandemic, the federal funds rate was cut tremendously to prop up the economy (this is one of the major pillars of expansionary monetary policy – it was reduced all the way down to 0.25% from March 2020 to February 2022). During this time, it was easy to take loans as the interest rate was virtually 0% for all practical purposes, which meant that investors could start investing in newer, more riskier markets.
During this time, many Indian startups raised a lot of money and started to expand tremendously (which was considered by many at the time as the golden age of the tech industry, because companies hired aggressively to meet demand & they could afford it as well due to a flood of investor money).
For example, Byju’s (one of India’s largest ed-tech companies) raised billions of dollars from investors like the Chan Zuckerberg Initiative, Blackstone, T. Rowe Price and Blackrock. With all this money at hand, Byju’s started to rapidly expand into other countries outside of India, aggressively bought up smaller startups and companies like Aakash, White Hat Jr., GeoGebra, & Tynker which costed the company billions of dollars in the process, increased spending on marketing, and hired a lot of employees to fill in gaps in their sales and customer service teams.
But when the pandemic ended and the interest rates went up again, many of these Indian startups were forced to pay back debts or loans they took up during the pandemic at staggering interest rates. Add to the fact that their revenue was way lower than their value, and you’ll see why many companies resorted to their last option: freezing hiring or laying off workers or in the worst case, defaulting on their loans and filing for bankruptcy like Byju’s did. In short, their fundamentals were bad.
Secondly, the situation in the Indian startup system was eerily similar to the dot-com crash of the early 2000s in the USA and therein laid the second problem. Similar to how many dot-com companies had bloated valuations and limited profitability, startups started rushing into sectors like quick commerce after the success of companies like Zomato, with investors getting really excited in the process and throwing millions of dollars into the process.
The issue was that there were a handful of companies who truly dominated the space with their distribution and speed and there was not much of a product differentiator because in the case of delivery apps, the same items that could have been delivered at a way cheaper cost by local grocery shops without a requirement to market their services. Add in the fact that the target base that newer startups were trying to reach out to (Tier 2 cities in India) primarily buy from these local store as it’s way cheaper for them and they don’t have to pay extra money for online deliveries when they can get the same groceries with no extra charges at local shops.
So, these small startups couldn’t defeat the giants with their distribution and pan-India reach and simultaneously couldn’t defeat local industries who could severely undercut their prices because they have zero/extremely low variable costs in terms of delivery and no requirement to charge more for delivery services, which is why many of them went out of business.
Thirdly, many companies over-estimate the Indian market, specifically the consumer base of India. For example, despite Zomato raising $1.3B from its IPO, the CFO of Zomato announced that they would be terminating operations in 225 cities. And even with the other 800, Zomato isn’t profitable with 60% of their revenue coming from just 8 cities.
The problem is that 80% of small stores (referenced in the previous argument) exist in Tier 2 cities in India, which makes the competition at these cities intense because these small stores can undercut delivery apps in the regions which makes profitability a distant dream for many apps.
On the flip side, people in metro cities like Bangalore or Chennai (Tier 1) generally are willing to pay for more expensive higher-quality goods because they have more disposable income than people in Tier 2 cities and are much more likely to purchase online rather than going to local stores. Moreover, out of the 300M households in India, only 10M of these contribute to 50% of India’s consumption and they’re located in just 30 cities across India.
Anybody outside of this bracket is extremely price-sensitive, which means that they’re very picky about what they purchase, which is the kind of demographic apps like Zomato cannot sell to. For instance, why buy a burger on Zomato and pay extra money for delivery charges (because delivering items in 10-30 minutes will cost more) when you can purchase the burger at a local restaurant with no extra cost? For people in these cities, their value is attached to money, and they’ll do anything they can to save it up. For people in metro cities, their value is attached to convenience and the time saved in deliveries, even if it means paying a bit extra.
Many VCs initially invested in startups with the promise to ‘capture the Indian market of more than a billion people,’ but over time VCs realized that they were being sold empty dreams because most of India couldn’t even afford the products and services that these startups were providing.
That’s what led to situations like TeachMint where the company was valued at $45.4M but only made $91K one year. TeachMint was able to recover the losses later, but not many companies are that fortunate. Even foreign companies (like Shopee from Singapore) realized how despicable the situation was and left India.
Many startups in India are not even trying to target Tier 2 and Tier 3 cities/consumers in India, with CRED’s CEO openly admitting that he’s only targeting consumers who own credit cards, and they have no intention of expanding to other cities. He’s not wrong, considering that only 5-6% of Indians even own a credit card.
That’s the state of India startups: grand visions only to be cratered by the reality of being able to only sell to Tier 1 customers (usually with cutthroat competition). This is the story of every single one of the 9 startups out of 10 created (whilst not usually the only reason, it does affect every single startup in some measure or the other.)
Lastly, startups in today’s economy must compete in a market which was virtually non-existent prior to the 2000s: the attention market. Startups must spend millions of dollars on marketing and sales, with very little upside at the end of the tunnel. For instance, business pundits generally recommend that the lifetime value of a customer should be 3 times the acquisition cost of that customer. In India, the ratio is 5 times the lifetime value of a customer which is being spent in marketing a product.
This was the reason behind the downfall of Byju’s (as earlier mentioned) and also the reason why the hottest ed-tech startup in India (Physics Wallah) is massively expanding. For example, whilst Byju’s ended up spending nearly $283M in marketing alone which accounted for a huge chunk of their costs, Physics Wallah spent around $113K simply due to the brand name of their CEO who was a famous Indian teacher on YouTube. That’s why Physics Wallah’s CAC is way lower than Byju’s, which meant that Physics Wallah became one of the only edtech firms in India to sustain a profit.
Not all is gloomy in the Indian start-up sector though, with multiple titans emerging from the Indian economy. And the good news is that multiple startups are mushrooming organically from tier 2 and tier 3 cities themselves, with the government reporting that nearly 50% of all startups come from these strata of the economy. Indian startups have been some of the most successful in the world and have provided millions of jobs to the economy. It’s just that the disparity between the valuation and the actual revenue is sadly unmissable and a huge turn off for foreign investors.
If startups can focus on developing amazing products and services people genuinely need (instead of developing ‘premium’ products and services no one really needs just to exit with millions of dollars or sell off to a larger company) and if the government can step up its efforts in strengthening the middle class of India who can afford to be part of the startup ecosystem as consumers, then we’ll be doing justice to the thousands of startups all across India. If we can fix these structural problems in the Indian startup ecosystem, that’s when the magic really begins.
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