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India, private equity and more ...

Monday, October 03, 2005

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 1st point impacts what kinds of products/services can achieve both scale and profitability. The 2nd 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)


At 2:09 AM, Blogger Boris Veldhuijzen van Zanten said...

There is a story in Guy kawasaki's book 'Rules for Revolutionairies' about the woman who invented washing machines. For the first few years she didn't sell any because the people who were supposed to buy these washing machines said 'maids are inexpensive, so why would I buy an expensive washing machine'. She the rebranded her product and started telling people that a washing machine was more hygienic than a maid because the plates were washed at higher temperatures. The washing machines took off imediatly and became a huge success. This was around 1900...

I just read your post and your remark 'vacuum cleaners never took off, since maids are inexpensive' reminded me of that story. Maybe someone should try to sell vacuum cleaners in India and market them as 'cleaner than a maid'.

It also reminded me of a story by Seth Godin who told us about the success of the design vacuum cleaner by Dyson. The reason why this vacuum cleaner is such a success is because guys (who don't even WANT to vacuum) bring them out when friends visit to show of the dust going around in the translucent compartment. It's not the price of the vacuum cleaner that made any difference because it's easily 10 times as expensive as most other cleaners. Price, is some cases, hasn't got much to do with anything.

Which might sound like an insult if you can't even aford to buy a handful of rice.

My point: Maybe India isn't THAT different after all.

On the other hand: 1 billion people with only 26 million mobile phones which a (per capita) purchasing power parity of 3100 compared to the US with almost 300 million people, 160 million mobile phones and purchasing power parity of 40.000 is quite a startling difference after all...

Boris Veldhuijzen van Zanten

At 2:17 AM, Blogger Kripa said...

Look forward to following this blog with great interest.

My annual 2-3 week visits to India serve as potent reminders of how disconnected I am with the "average" Indian. Your point about the informal working segment of India's work-force ("unorganized sector is here to stay") rung especially true.

A couple of relevant factoids from the most recent Govt. of India economic survey (2004):
Less than 10% of the workforce is part of the organized sector; 19mm of these 27mm are in the public sector. Most policy and legal reform is effective within this organized sector.

However, as may be expected, organized sector operating leverage and segment focus allows it to account for over 35% of net domestic product.

As a very high level first order opportunity metric - every 1%migration of unorganized to organized labor should yield production increases of 2-3%.

You figure this should help drive structural change, but change appears to be gradual- in 1999 strength of organized sector was 28mm, compared to 26mm in 1990. I do admit there is a public to private trend that belies this overall small movement, however, the overall number is still not very different from the recent 27 mm number. This does substantiate the here to stay assertion.

Having said that, I would love to know more about successful (read profitable) businesses that have been driven by "organizing" portions of this vast un/semi-skilled labor force.

At 12:16 PM, Blogger Neelakantan said...

The point that you make is well taken, but then cellphones hardly qualify(ed) as basic needs. The trick is, perhaps, to offer a service (like cellphones), package it smartly (prepaid etc), create a value proposition that makes it smell VFM. I agree with boris (1st comment) on this point.

But there is also a market for "elitist" services like broadband. Rather than competing against the "unorganised" sector, organising it is perhaps a business idea. (Maid agencies, Le Concierge and so on). Perhaps will do a post on it sometime!

Nice beginning to your blog though. Keep posting!

At 1:48 PM, Blogger Pravesh Biyani said...

Yes, I totally agree with you Anant. The point that every business in India is missing is the overestimation of what exactly average ( $2 a day ) consumer needs. That is why we have not been able to create many bharatis and reliances. People needs to come with ideas that are more pertaining to the bottom of the Indian consumer pyramid, providing quality health, education and infrastructure.

At 4:43 PM, Blogger Rajan said...

An excellent and well written post !!

There are some trends which I am observing does'nt fit in very well the model that you have explained but I don't have any study/numbers to back the observed trend.
People are ready to download tons of ringtones which is priced 8 Rs. Every mall (in class A cities) are brimming with people where most there splurge money like anything. It foxes me given that our country has such a low per capita but then where is this consumption thrift coming from.

Is it just an outlier or a small portion of indian population that I am looking at.

At 8:59 AM, Blogger Anand Sridharan said...

Boris, I do agree that revolutionary businesses are built by people who break conventional rules. In fact, I'd love to see people do that in India, irrespective of whether these are home-grown or global companies.
My main message is to "Systematically look at the real facts beneath the hype". In most cases, the opportunity is still there, but the way to go about it needs to be tailored to the Indian (or any other) context.
One "food for thought" to Rajan's comment - it is apparent that the malls are brimming with people. The real question is how much is actually being spent vs mere footfalls?

At 12:05 PM, Blogger KoPoS said...

The 8/- per ringtone downloading folks and the mall-visiting folks in India are a very very small segment of the spending population in India, which im sure amounts to much less than the 1% to 2% of the population.

The markets and hype that is being talked about in the media is just a minority; a top-rung elite noveau rich bourgeiose, i will daresay its a negligible number compared to the numbers who cant. The sheer volumes available in India makes that minor 2-3% a huge market.

Sadly the first group is as much a contributor to the percapita as are the latter group.

At 9:18 AM, Blogger Mukul Chawla said...

I am intrigued by your suggestion that the likelihood of the next Campbells Soup or General Mills from India is small.

Im in the process of researching if a real opportunity exists in food processing, and based on anecdotes, I think the cost advantage offered by cheaper (compared to global prices) inputs into Indian food processing (agricultural produce) may give India an advantage in the global food processing market, even if there is some offsett due to transportation costs. I learnt recently that a large % of the world's apple juice is now being produced by local manufacturers in China, why cant India do the same?

I realise your comment was with reference to the local market, but perhaps a (branded?) large food processing opportunity exists in the world markets, served out of India.

BTW, My bio - BITS Pilani, UIUC, Wharton, worked at Cisco Systems before b-school and at McKinsey this past summer, am in the 2nd year at Wharton. I see some familiar names on your blog - I have spoken with Dinesh Vaswani in the past, and VT Bharadwaj is my junior from Pilani.

At 7:07 PM, Blogger Akshat said...

I agree with poorna that maybe 1 or 2 % of India is visiting malls, and spending money on mobiles and ringtones....but one must remember that 1 or 2 % of 1 billion is 20 million.....which is more than the no. of people in many nations.

Now the interesting fact is that these people are willing to spend money...and one would like to target them...but the flipside is that unlike many nations this 1 or 2 % is spread over a large area and are very diverse....

so how does one build something for them....these guys have one thing in common...that is access to mobiles and internet and that is precisely why these two mediums will have great value in India.

At 1:18 AM, Anonymous Shuchi Mehta said...

Hi All
Great Article/perspective on India & the Indian consumer.
I have limited knowledge and exposure but would still like to comment!
I agree with Anand when he says we need to look at the BIG picture the, a majority of consumers of Indian consumers actually live beyond Andheri Station (which many marketres refuse to see)
and I have had the oppurtunity of meeting some of those consumers specailly in the North Indian states.
and my conclusion after those visits has been ,that we can reach out to them with a variety of products even washing machines or dishwashers or anything highly technical!
Because they all are willing to listen and learn about new things!
Media/cable TV has been playing a major role in doing that job for us, it raises the aspirations of a villager and a metropolitain equally.
Also if my understanding is correct India today has the maximum number of individuals in the the ages of 20-40 years ie the Young population is largest!
May be this generation can do what the Baby Boomers did & are still doing for the US.


Shuchi Mehta

At 8:48 AM, Anonymous Wong Online PoKér Hu said...

India is making a climb in the sectors that used to be her waterloo. I also think that India is making a headway in advancing the technology. Morever, these indicate that India is pushing hard to fulfill its economic potentials.

At 4:03 PM, Anonymous Anonymous said...

I see no mention of opportunities in the educational sector. If one thing middle class Indians will spend tons of money on is a good quality education. I think it is the next billion dollar opportunity.

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