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India is arguably the most promising Internet market in the world. It has attracted over $20 billion of global venture capital, primarily from Silicon Valley. The Chinese will add billions more to this pool. We are the third hottest start-up nation in the world—just behind the US and UK, with over 4,000 start-ups. Facebook, Google and WhatsApp are betting big on India. Our mobile penetration has crossed the billion mark. We’ve got 300 million smartphones, and growing.

By all counts, we should be happily dreaming of multibillion-dollar initial public offerings and a vibrant exit system. Yet we are not.

Look under the hood—you see a crisis of confidence today. Venture capitalists (VCs) have pulled back. Series A funding is at an all-time low and “consolidation" is the nickname for the desperate rescue of investors in dud start-ups, which are quietly euthanized a few months later.

Across logistics, e-commerce, food tech and hyper-local services, several hyped-up Western clones have been decimated. A deadpool list puts the number at 800 but my hunch is that this could be double that.

In excess of $2 billion has evaporated over the last 12 months—with nothing to show for it, except jobless techies, sales people, coordinators and courier boys. Over 10,000 pink slips have been issued in the last six months, not counting the losses at ancillary businesses that sprang up around them.

Founders have realized that raising lots of money is not the recipe for success. In the last five years the exact opposite happened: mega-funding killed the innovation and hunger, the leanness and the sharpness. It created sprawling teams without focus. Investors were blinded by the growth story and did very little diligence on teams and their maturity to find product-market fit. Funding became the distraction. The biggest startups in India fell complacent by their own admission. Mega-funding rounds ended up attracting foreign strategic competitors like Amazon and Uber far earlier than planned.

Flipkart and Snapdeal are estimated to have burnt through $3.5 billion so far to generate gross merchandise value of $5.5 billion this year. If you assume their “take rate" at about 8% (commission revenues they derive from a transaction on their marketplace) their generated revenue will be just about $400 million. This kind of capital inefficiency boggles the mind.

So, here’s the moot point: Did something go terribly wrong at the confluence of young start-up founders, mega-round capital and proven business ideas? Or was the huge market potential in the Indian Internet space a chimera?

There are two parts to this narrative: start-ups hitting a glass ceiling and the fallacy of “one" market. Let’s take them one by one.

1. The glass ceiling: A year ago e-commerce players realised that they had exhausted their “consumer runway". There was a limit to the number of Indians who speak English, have money for data packs and have the personal disposable income to fill their closets with clothes they don’t need based on offers they can’t resist. The returns on customer acquisition and retention costs were negative, and splurging on ads did not expand the customer pool.

This math was conveniently ignored because they had to show higher gross merchandise value to attract investors. But there were other troubling signs too. When they cut back discounts due to changes in government policy, e-commerce shipments tanked across the board. Smartphone growth, an indicator for the potential of our consumer Internet market, slowed to just 17%. Telecom operators reported slowing data pack growth for the first time in years. There is a growing realization that the Indian market is not as deep as they thought. Almost on cue, the narrative shifted from “India will be the next China" to “India is not China."Does this mean the market is small? Not at all.

2. The fallacy of ‘one’ market: Google, Facebook, WhatsApp are huge, ubiquitous services with over 95% penetration in our market. They will soon reach a majority of our potentially billion-strong Internet users—most of these new users will rely on their smartphones for digital access.

But these services are free. They make money from advertisers and not consumers. And their average revenue per user (ARPU) in India is a mere fraction of their global average.

So it’s not that our market is small, but the way it is configured that trips up every player who tries to treat it as “one" market. The multinational companies and big-box retailers in India learnt these lessons the hard way a decade ago and now we are seeing the tech startups face up to the reality. The reason to worry is this: most Indians cannot afford a decent meal, let alone buying stuff online or hailing an on-demand cab.

Let’s turn to the math.

If you stacked up a 100 Indians, here’s how our income distribution looks:

One Indian earns 30% of the total and makes over Rs1.5 lakh a month. Fourteen Indians earn 30% of the total and make around Rs20,000 a month each. The next 30 Indians earn 30% of the total and make Rs8,000 per month each. The poorest 55 Indians earn 10% of the total and make only Rs1,500 per month each.

Mind you, this is total income. This is money they earn to spend on everything—roti, kapada and makaan, and of course, data. Most of this money is spent on food and groceries, and on things they “need". Money left over to buy things they “want" is much lower as you go down the chain.

The wealth statistics are even more damning:

One Indian owns 53% of the wealth

Nine Indians own 23% of the wealth

Forty Indians own 20% of the wealth

Fifty Indians at the bottom own only 4.1% of the total

(Note: These are rough calculations and I abstain from using the phrase “Indian middle class". There is just too much confusion around how big it is.)

Simply put, we live in three countries:

India One: Club the top two tiers above and you find that the top 15% of Indians, i.e. about 150-180 million, earning an average of Rs30,000 per month, are the ones who have money left over after buying necessities. These 15% of Indians control over half the spending power of the economy and almost its entire discretionary spending. They consume their data plans without thinking about the bills. They install the shiny new apps without bothering about the gigabytes they consume on their oversized and expensive smartphones. They have Wi-Fi at home and office, power generators at home and are connected 24x7.

They are equivalent to a country with the population of Canada and live the lifestyle of a European nation (if you equate them on purchasing power parity, or PPP basis)—and with better lifestyle to boot. They have chauffeurs, maids, cooks, cleaners, peons to take care of onerous chores. And no, they won’t step out of their air-conditioned homes into our dirty streets and traffic—everything has to be served instantly, at home. Assisted living at the age of 20, I call it.

India Two: This is the middle 30% or 400-odd million Indians, earning an average of Rs7,000 a month. This would be a country about three times the size of Bangladesh with a similar level of purchasing power.

They are the ones who “service" the $1 trillion market (yes, read that again) that India One represents. That’s the money that trickles down to them.

They have managed to change their fate and climb out of poverty over the last two decades by migrating from their tiny bits of non-arable land to the mega cities of India and taken up jobs to serve the needs of these markets. They work two shifts as Uber/Ola drivers or as cooks in our burgeoning restaurant chains, or set up small businesses—and send money back home to their families in the villages.

Luckily for us, they still see hard work, family values and education as a ticket to a better future. Most save all their money to get their kids an education. Most of their income is spent on food and rent, and whatever little is left they use to try and escape from life in their smartphone screens by buying movies or songs on an SD card from the neighbourhood store. They buy second-hand smartphones and tiny sub-hundred rupee data packs to keep in touch. Of course, we report them as Internet consumers in our slick presentations on Startup India.

India Three: These are the forgotten 650 million who subsist and don’t have the money to buy two square meals. Their incomes are on par with those of sub-Saharan Africa. Many of them did not leave our roadless, school-less, toilet-less, and powerless villages and instead chose to send a child or a sibling to work in the big cities. They live on the mercy of our monsoon and whatever little reaches them through our poverty alleviation programmes. They live on the periphery of our economy and for all practical purposes don’t participate in it. However, they are the ones who form our vote banks and determine the political future of our nation.

These three Indias are not split geographically. The steady urbanization of our nation has seen to it that all three mingle together in our metropolises—from Dharavi to Dadar to Malabar Hill in a city like Mumbai. We share the same roads, air pollution, and same GSM spectrum from our favourite cellphone operator. What joins our existence at the hip is the cellphone and the constant fear of its battery running out.

Failure of the smartphone proxy

The failure to distinguish between “Internet users" (India Two) and “Internet consumers" (India One) has messed up every estimate of the market. This destroyed the Total Addressable Market (TAM) calculations that have driven most venture capital funding and valuations. TAM—of people who can afford to actually habitually spend on the current offerings of our Internet giants—is not 1 billion people, it is about 150 million people.

This changes things. Let’s see how.

E-commerce players talk about how their penetration levels are low and they have a huge upside. But the moment you redefine the addressable base—i.e. assume it’s not 250 million households but closer to 40-50 million with discretionary income—our online shopping penetration suddenly rivals the best markets in the world. It is obvious that with so much media blitzkrieg and mind-boggling discounting, most of the households that could afford to make online shopping a habit have converted. The market has saturated, and growth will slow. Quite simply, investors and founders who took our explosive mobile and smartphone growth as a proxy for the potential of our consumer Internet market are paying the price. The bubbles are not just in their valuations but in the business models that assumed a far larger addressable market than there is.

So how does one look at the market today? First recognize that the smartphone is not an indicator of spending power, it is an instrument for survival. Almost 60% of Internet users in India don’t access it more than once a day. These are not Internet consumers, but just Internet users—they use it like a utility, with an eye on the data consumption. The addressable market for a start-up will now need to be tested for real. Someone will have to go and check on the ground whether the customer can actually afford it, repeatedly, or will it be a one-time sign-up driven by the incentive of a free Rs20 talktime recharge—something that sounds pretty good to someone living on a data plan of Rs100 a month.

If anything this “reset" augurs well for our future. The golden moment for India’s Internet market is coming. VC dollars will now naturally get directed towards India Two and India Three. But they need a different mindset and solutions. They may not live up to the script of I-will-be-a-unicorn-in-24-months, but will have the potential to give birth to several “centaurs" for the next decade.

What will aid them is the fact that the country is about to get data-charged. We will add 200 million smartphone customers as smartphone prices dip below Rs3,000. Reliance Jio’s entry will reset data prices in India. My guess is that entry-level data packs will cost a third of what they are sold for today—in just a few months.

And wired broadband, which has been ignored far too long by our successive governments, will take off finally. A 10% increase in broadband penetration increases the per capita GDP by 1.38% in developing countries, according to the World Bank. India ranks No. 4 on smartphone ownership, but 122 on broadband. Access to cheap, good-quality bandwidth will make vernacular and video the accessible language of digital interaction. Data will be the new arterial network of India.

Cheap Internet access and low-priced smartphones, combined with the public digital goods (the identity and trust layer provided by the India Stack) being built around Aadhaar, and a maturing startup ecosystem will create the next set of uniquely Indian technology start-ups.

India Stack will craft a new friction-free, lower-transaction-cost highway that will be accessible on the mobiles of Indians regardless of their income and literacy. It will create a truly integrated market. A year ago, I had tweeted that there is a billion dollar opportunity in building your business on this platform.

Though we pride ourselves as a country of entrepreneurs, we make a big mistake. Most of our self-employed in India are entrepreneurs by default for lack of other opportunities. They work in small shops and farms, often in poor conditions. They lack the capital and tools to grow and are forever stuck in the uncertainty of self-employment and the vagaries of the market and weather. These sub-scale firms that barely sustain the livelihood of one family are a drain on our economy and resources. We have to de-clog from millions of tiny businesses and get employment going. As India Two and India Three go online, the people who could not participate in the economy due to lack of physical and financial infrastructure, will turn into consumers and “micro-entrepreneurs". The kind of entrepreneurs I am talking about will embrace technology and the connected ecosystem to scale their business, creating wealth and jobs.

This is the Green Revolution, the Milk Revolution at 100x the scale and impact—something that has never been seen in any market in the world.

So what does it mean for VCs and start-ups?

The traditional VC model bets on a few winners and deep markets, which are quickly penetrated by access to mobile-connected audiences and are mega-funded to disrupt traditional markets. Indian VCs will need to balance a “nurture and grow" versus a “spray, burn and pray".

In China, Internet retailing grew 50x in the seven-year period 2007-2014 on the back of 7x growth in user adoption and 7x growth in annual spending on e-commerce. In 2014, China had 10x the number of middle-income households compared with India. We can’t catch up with that anytime soon. That kind of growth is still 10 years (or more?) away in India. So VCs need to recalibrate their thinking. Of course, you may find a startup with great product-market fit, but the viscosity and the shallowness of the Indian market will slow you down. So you have to have the patience to see it achieve scale. Start-ups will have to play the game very differently. First, they have to recognize that India One will remain hyper-competitive with the global players always ready to jump in. This market needs start-ups that tailor their offerings to these audiences who value convenience over economy. Here the challenge would be to drive both usage and ticket size. This will be a tough market to fight.

There is an opportunity in India’s traditional businesses. Every sector has infirmities and yawning gaps that a start-up can drive a truck through. Most Indian old-economy companies are caught like deer in headlights—every CEO wants an app or a website but few have a clue on how to make it a real business. A quick glance at the websites of the offline retailers will tell you that even after they were hit by the online tsunami over three years ago, they’ve yet to put up a semblance of a fight. There’s a huge opportunity here.

Winning here won’t guarantee that you will still be relevant in a few years’ time, since you’ll miss the benefits of scale if you ignore the India Two and India Three markets. We need a “Nirma moment" in our start-ups. And the Nirma moment does not strike you while you sit in the cozy quarters of Koramangala.

The consumer Internet businesses for India Two and Three will have a different agenda—they will need to focus on reducing costs and friction, and not just on overloading the consumer with choice. So how can one frame the opportunities? While it’ll be most interesting to get the reader’s take on it, I’ve tried to bucket them into three types:

1. Bridging the divide: These are firms that would build the bridge between India One and India Two—that rework their offerings to match the aspirations and affordability of India Two. Who can refurbish goods, sell more affordable unbranded products, and communicate with the India Two consumers in their language. Group-buying platforms for consumers and small and medium enterprises, second-hand cars and two-wheelers are some examples. A player like ShopClues is the Indian dollar store or the flea market has made a dent here.

2. Create new markets: Start-ups need to learn how to “sachetise"—how to strip down ideas and services and match the affordability and aspirations of India Two. For instance, they need predictable and cheap transport. Can’t we create a bike-hailing service, like Go-Jek in Indonesia?

3. Inform, empower and entertain: India Three customers need start-ups that can disintermediate exploitative middlemen. For example, “direct to farmer" m-commerce platforms like AgroStar. They need apps that can make a village act as one and increase their collective bargaining power. They need information apps that can help them choose the right crop, do the right investment, take care of their health and fitness, lead a better life. These are lessons for founders: A big round of funding doesn’t translate to success. Ingenuity comes first. If you get that right, the funding ecosystem is now large and deep enough to back you as you scale.

Get fascinated with India Two and Three for the next five years. You can create moats and stickiness in these markets. They are first-time Internet consumers. They need guidance and solutions that can transform their lives. You don’t have to go far to understand their needs; they live next door, in the chawls of your city. Learn from Patanjali as much as you learn from Amazon and maybe you’ll truly find the pot of gold beneath our pyramid.

Every start-up doesn’t have to be a unicorn. No need to burn up like the legendary Icarus as he affixed wings made of wax which melted when he tried to embrace the Sun. I’d say, instead work on growing real wings and soaring—they take time to grow, and the journey is longer, but they won’t melt at the first sign of heat.

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Haresh Chawla was founding chief executive of Network18. He joined the firm in 1999 when it had revenue of Rs15 crore. When he moved out in 2012, he had built it into a Rs3,000 crore media conglomerate. He is now partner at India Value Fund, and mentors several start-ups.

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