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B2B And Manufacturing Start-ups: The Struggle Continues The yearly losses of most B2C unicorns are alarming and, in many cases, exceed their turnover

By Sudhir Mehta

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Past decade has witnessed a spurt of start-up launches, making the country one of the fastest-growing ecosystems for start-ups. Most of these start-ups have mushroomed in the business-to-consumer (B2C) segment and are engaged in a frenetic race to grow their market share and customer count. Profitability, management continuity and ownership often rank low in the race to gain high valuation. More than 46 per cent of start-ups funded last year are struggling to raise follow-up capital. Exploding valuations and the success of early-stage funds has billions of dollars chasing more than 19,500 start-ups. Fast-rising Internet penetration, increasing smartphone usage and growth in online retail has resulted in stratospheric valuations and multi-bagger returns for investors in B2C enterprises. The government has also hopped on to the bandwagon with the "Start-up India' initiative. But this dream run is about to end, like all good things do.

Many of the B2C start-ups are premised on replicating the success mantra of the West. The investment "story' for these start-ups is based on grabbing "real estate' and growing market share and size. Profitability is a dirty word.

The yearly losses of most B2C unicorns are alarming and, in many cases, exceed their turnover. The reported losses would be even higher if one excludes other income (interest income emanating from investing surplus funds raised by them). Moreover, most losses are not for physical asset creation or technology deployment but for "customer acquisition'. Following the Western model, the most asset-light start-ups with a growing customer base command the highest valuations. The deliberate selling of goods and services much below cost assumes that the consumer will show long-term loyalty, and eventually prices will move to "normal' or that competition will die allowing for better realizations. Both are fallacies as the Indian consumers are extremely value-conscious and very amenable to switching providers for a better deal. The Reliance Jio, for example, where 50 million subscribers came on board thanks to freebies is a case in point.

The Bharatiya Janata Party government has launched various initiatives since 2014, including Start-Up India and Make in India to promote investments in manufacturing, innovation, R&D and capability building. Manufacturing is the backbone of the country, contributing to gross domestic product, providing employment, driving domestic consumption and helping in substituting imports. Logistics, infrastructure, information technology and communication, among others, are ancillary sectors that grow along with manufacturing, adding to employment generation and growth of the nation. Providing impetus to manufacturing start-ups in the country is significant for achieving the vision of "Make in India' and budding entrepreneurs should play a key role in taking this campaign to its next level. The next generation of Indian start-ups should focus on the application of modern technologies in domains such as automotive, logistics, hardware and food processing, but given the challenges in manufacturing, not many entrepreneurs and investors are looking at investment in this sector.

Initial capital investment in manufacturing is often so large that entrepreneurs are shying away from them. Add to this, lack of availability of affordable land and skilled labor are other hurdles faced by the sector. Rapidly changing market dynamics and longer gestation periods make VCs and PEs less enthusiastic about the sector. Despite government's push to create an ecosystem that can be conducive to growth in manufacturing, efforts don't seem to be fructifying as desired.

For India to attract and sustain the VC funding momentum, the paradigm needs to morph to sustainable innovation and IP creation rather than predatory pricing. The flow of funds to enterprises which create genuine IP or are focused on manufacturing and R&D has been limited, as revenue takes time to appear. But the irrational exuberance for marketplace start-ups will slowly move to the above category which has a better chance of sustainable profitability. There is also an untapped opportunity in business-to-business (B2B) ventures provided they bring innovation. India, given its large pool of talent, can become the R&D hub for the world. Government-supported VC funds should restrict themselves to investing only in social enterprises in sectors such as water and agriculture, among others. For B2C start-ups, it is time they look at every rupee of spending to see if it creates sustainable value. Also, many of them may need to pivot their business models from being pure B2C ones to other niche sectors. They can also benefit by adding experienced leadership from brick-and-mortar industries, which are used to a certain tradition of frugality.

One large manufacturing unit provides an impetus of growth to several micro, small and medium enterprises (MSMEs), which are the engines of growth for any nation. In India, MSMEs contributes 31 per cent of the GDP, 45 per cent of exports, employs over 124 million people and create nearly 1.3 million jobs every year. Entrepreneurial growth and development are not restricted to the urban sector only, of 55.8 million MSMEs, 59 per cent are based in rural India. Adequate and timely banking finance, non-availability of new-age technology, high cost of credit and overregulation are some of the factors impeding the growth of this sector.

Modi 2.0 should focus on:

  • Providing affordable finance to the manufacturing sector
  • Develop skilled labour by involving ITI to cater to the sector
  • Provide sops to VCs and PEs for investing in manufacturing startups
  • Encourage entrepreneurs to invest in newage technologies, innovation and R&D
  • NBFC and bank financing should be simplified, fasttracked and encouraged

As per IFC report 2018, overall finance demand by MSMEs is estimated to be around INR 87.7 trillion of which approximately INR 69.3 trillion are debt requirement of which nearly INR 48.5 trillion are required for working capital and close to INR 20.8 trillion are capex investment required for fixed assets.

Global brands such as Nissan, Hyundai, Ford, Skoda, Nokia, LG, Samsung, Airbus, Cummins and other few high-end luxury brands have indicated to set-up their manufacturing base in India. While this may provide an overall boost to the manufacturing sector and GDP, Modi 2.0 needs to focus on developing Indian brands and encourage Indian entrepreneurs to set-up manufacturing units to become globally competitive. Cash-rich PSUs such as Life Insurance Corporation of India should come forward and invest in manufacturing start-ups rather than focusing on bailing out troubled businesses.

Technology provides the opportunity to build differentiation and innovate on experience. In India, we need to move beyond copying Western models and focus on building our own IPs. Several companies that failed to do so are now at risk of being dislodged by the "originals' as India opens up its markets. The first signs of this realization are the recent write-downs in the valuations of some storied unicorns. Looming global slowdown combined with the short-term pain of demonetisation may hasten this process. Some of those affected are now asking the government for protection, but that is unlikely to work.

VC funds that have been complicit in the rush for market share need to realign their focus, on returns and investment in building technology differentiation. Companies such as Infosys and Wipro, which have created sustained encashable wealth, have done so with judicious use of capital and control on costs. The ultimate test for start-ups will be when they go public and value is determined daily by millions of investors.

With the world impatiently watching India's growth and citizens of the country expecting a quick turnaround in economy, consumption and job creation, Modi 2.0 has a large task on hand before the next elections. Turnaround in economy and job creation are the only motivation that will ensure continuity of the government and for this quick and bold steps are the need of the hour. A "bhujaal' should shake the existing manufacturing sector with a gush of new enterprises focusing on new projects, new investments and R&D.

Sudhir Mehta

Chairman and Managing Director, Pinnacle Industries

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