India’s technology landscape can be characterized as having seen three waves of evolution and growth. The first wave was led by the likes of Tata Consultancy Services, Patni Computer Systems, Infosys and Wipro, who pioneered the outsourcing model based on labour cost arbitrage. These were firms founded in pre-liberalization India and took decades to establish themselves as global brands. The second wave occurred in post-liberalization India of the 1990s, when several IT firms adopted similar business models to the outsourcing pioneers. The small- and mid-sized enterprises that emerged during this period strengthened the foundation of India’s nascent software services industry and today form the backbone of that thriving sector. The third wave can be said to have begun with the advent of the Internet – startups such as Naukri.com, MakeMyTrip.com, InMobi and Flipkart.com who have emerged as category leaders in providing web services.
The common thread to the three waves has been the domination of the services-oriented software and Internet companies, and in recent years, the preponderance of ideas that have worked in the West that were repackaged to suit the Indian context. The fact is India has seen more imitation than genuine product innovation.
India’s technology industry has been dominated by IT and Internet firms, and venture capital investment figures for recent years bear out this trend. Since 2009, VCs have poured over $810 million into 113 deals in the software, mobile and Internet sectors. In contrast, early-stage health care and clean technology companies have received $292 million across 71 deals. It’s also interesting that average deal sizes are larger for early-stage companies in software and Internet than for health care and clean technology – one would have thought that the former is less capital intensive than the latter, and would hence require lesser capital to grow at the early-stage. By some estimates, India’s software and Internet ventures have been raising larger amounts of early-stage venture funding than American clean technology startups.
The data points to a clear mismatch both in terms of funding size and sectoral capital allocation. My hunch is that most investors who have put capital behind consumer Internet startups trying to build commoditized businesses will lose money. Most of these ventures are pursuing unsustainable business models. As if having imitators of American Internet startups wasn’t enough, we’ve seen imitators of Indian imitators of US Internet startups successfully raise funding. These ventures have almost no pricing power and hence almost no profitability. A fund raising arms race is under way, and the vast majority of startups will lose out as capital providers cluster around the top 1 or 2 category leaders.
In a more rational world, India’s VCs would bring together some of the outstanding engineers and scientists working at corporate research laboratories operated by Fortune 500 giants like General Electric, who are conducting key R&D work that is in many cases indispensable to the parent company. VCs should be willing to back stellar teams pursuing big ideas, and should invest capital in ways that harnesses the economics of outsourcing to deliver path-breaking innovation.
The data also tells us that more India-focused venture funds will be forced to look in places other than the tried and familiar Internet and IT sectors. Health care, clean technology and energy are mammoth markets that are relatively underserved and in dire need of early-stage capital, particularly for areas with substantial technology risk. Investors are beginning to recognize this, and several new funds have emerged that are both willing to look beyond IT and are comfortable backing early-stage ventures with $1-2 million.
The emergence of product-driven companies in sectors such as life sciences and clean technology in this decade will mark the fourth wave of the evolution and growth of India’s technology landscape. India’s talent base extends far beyond computer science and IT into fundamental sciences and engineering – it’s only a matter of time before risk capital connects with this talent base to deliver world-leading product innovation across more sectors. In order to achieve outsized returns, investors should skate to where the puck is going, rather than where it has been, to quote ice hockey player Wayne Gretzky.
(Rajeev Mantri is executive director of venture capital firm Navam Capital.)
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