Investing in India (1 of 3) - Domestic market

Over the last many months, planeloads of VCs have visited India, looking to understand what this India-thing is all about and (hopefully) invest in exciting Indian companies. Between CIOs looking to get code written in India, CFOs wanting to get invoices processed in India and VCs trying deploy capital into India, our 5-star hotels are both full and bloody expensive (Rs. 12,000/night in Bangalore – no complementary breakfast)! India is definitely a great place to be right now, with every company in the world looking at Indians either as consumers or employees. However, there are some home-truths about India that potential investors (and pretty much anyone else looking at the India opportunity) should be aware of. These are especially relevant when one looks at ‘Investing in India for India’ – where domestic demand is the main driver. These commonsensical fundas don’t make the macro-opportunity any less attractive, but may just help in figuring which kinds of business models are best suited to the Indian market.

Having grown up in middle-class Madras, I used to think that I understand how the average Indian consumer behaves. A recent review of some statistics proved me wrong. Based on proxy indicators – my parents had a (company-provided) car, 2-bedroom flat, colour TV and fridge since the early 80s - I now realize that we actually fell in the top 1% of Indian households (it certainly didn’t feel that way back then). Thanks to inheriting some of my parents’ intelligence and their wise pressure to make me study hard, I am now even less representative of the average Indian. Several products and services that I’d be willing to pay for are limited to a niche segment of the Indian populace. Quite often, this personal bias subconsciously permeates my (and others’) investment decisions as well, leading to companies and business models that simply cannot scale in India.

I define scale as building billion-$ companies tapping Indian domestic demand. I am sure there are niche opportunities that will profitably reach 10s of million dollars. But, don’t we all want to find the next google (or at least, the next Bharti)! If this is your goal, ALWAYS remember that if you are fortunate enough to be reading business plans, you are most certainly not the representative Indian middle-class (leave alone poor) customer.

So, the 2 obvious home-truths are:

1. Despite the new daily-high that Sensex reached this morning, we are still quite poor

The average Indian earns $2/day (at today’s prices) and spends over 80% of his/her income on necessities such as food, rent & utilities, transport, communication and clothing. The balance is predominantly used for the more longer-term necessities – health, children’s education. The oft-quoted and poorly-understood 300-million strong middle class is somewhat better off, but still has a similar share of wallet. They earn more, but live in proportionately better houses and eat more nutritious food (still, well below western living standards). Even the 300-million number is misleading (will cover this in a later post). Even my eternally optimistic McKinsey colleagues (led by good friend VT Bharadwaj) put this number at under 200 million (see “Winning the Indian Consumer” in the recent McKinsey Quarterly).

2. The labour pool for simple jobs is practically infinite.

The same report estimates over 750 million Indians in the ‘struggling’ and ‘destitute’ segments. Any capital vs. labour allocation decision needs to be viewed in the context of this near-inexhaustible, available and willing workforce, which can perform low-to-moderate skill tasks. 600 million farm labourers each earn ~$1.5/day, that too only in the harvest season. Their actual (or impending) migration to cities keeps wage rates low and inelastic for all low-skill jobs.

The 1^st point impacts what kinds of products/services can achieve both scale and profitability. The 2^nd point impacts how one should go about delivering these. So, what does this mean for investors and entrepreneurs looking to build billion-$ businesses:

1. Stick to basic needs

It will take us a while to get to self-actualization needs. Health spas, blogging and other self-indulgent pastimes will remain pastimes, not businesses. Billion $ businesses are most likely in food, clothes, basic infrastructure (roads, houses, health, education), communication, transport, household goods.

2. Think utility, not fun

Middle-class Indian households are used to an all-encompassing entertainment budget of $1/month/head for unlimited cricket, news, songs and movies. And this even includes the EMI on the TV (in addition to the cable bill and a newspaper subscription). No one is in a hurry to pay $5 a pop for a mobile phone game.

3. Price rules – but think VFM, affordability, TCO

Necessity makes us smart consumers. I worry whenever entrepreneurs talk of convenience and choice, without mentioning price. Classic example – Indians buy 2 million cellphones a month, compared to under 100,000 PCs (only consumer sales). Why? Greater value-for-money (most small businessmen actually make up for its cost through higher revenues). Low entry cost ($10-20 to go mobile). No other costs that add to TCO (PC ownership cost equation gets messed up by expensive home internet costs).

4. Unorganized sector is here to stay

With plentiful & cheap labor, there will always be an unorganized sector that is extremely efficient. Factory-processed foods will compete against local kitchen-help. The latter can typically deliver better taste, freshness and convenience, at a lower cost (remember, no overhead, no taxes). So, its going to be far harder to create the next General Mills or Campbell Soup in India. Similarly, kirana shops will stay long after FDI in retail is opened up.

5. Think hard before substituting capital for labor

Western capital-intensive models are often uncompetitive. Both at home (vacuum cleaners never took off, since maids are inexpensive) and in companies (high-volume flour mills still cannot match local ‘chakki-atta’ costs, in the $15 billion wheat-flour market)