Why India does not have technology-based product companies in the startup ecosystem
Speaking at a conference in India recently, Steve Wozniak, the man who co-founded Apple, noted that he does not see big advances in technology from companies based in India. The growth of entrepreneurship in India has resulted in a plethora of startups and many large companies, but according to Mr Wozniak, there have been a dearth of world-class product or technology companies being produced from the startup ecosystem.
Assuming he means companies producing a physical product (phones, hardware, electronics, and pharmaceuticals) as opposed to software or services, then I, for one am not at all surprised by his comments. There are few, if any, semi-conductor companies, electronics companies, pharmaceutical companies, hardware computer companies or home appliance companies that are truly producing the product themselves that have emerged from the Indian venture ecosystem to date.
While the whole ecosystem is young and still in the early stages of evolving, the lack of large, renowned product companies is striking but not unsurprising. There are several reasons for this, not the least among them the financing environment in India for entrepreneur's trying to build product companies is not at all conducive to them.
Compared to service sector companies, or software companies of all sorts, product companies generally require much more capital and have increased risk due to their longer development cycles. In addition, technology and the resulting product development takes far more time to mature than few months. It often takes to produce a software product, result of customer testing and iteration cycle required to modify the product when compared to software development is also longer.
It is more time consuming to change the hardware design, or plastics (even with 3D printing) than change software code. In addition, product companies with few exceptions sell their products at a price that is generally directly correlated to the cost of production of the product.
This results in lower gross margins when compared to software, which has no actual production cost and is sold at close to 100% profit on a unit economics basis. Finally, the product innovation cycle as well as the lifecycles of products are such that there is a regular need to innovate and update the products, which again requires capital, at least when compared to a software or services entity.
Building a software product (especially a mobile application) or building a services business requires very little capital before there are potential indicators about whether the software is catching on or has a market. Investors like this because they can provide a small seed capital round, have the entrepreneurs build the software application or cloud platform, check product market fit, and then provide more capital in a series A or B round.
In the investor's view, the risk associated with the business is mitigated with this strategy when compared to a technology-product company. Imagine a hardware company or a semiconductor company in comparison. The product cycles are such that the design of the hardware or chip, the printed circuit board, the plastic housing, and the rest of the accessories are months if not years. And all of that is a sunk cost in both time and money.
Finally, when the product is released as an alpha or beta, there is little margin for error and little room for iteration unless further capital is infused into the company. Though the long product cycles and investments may be worth it, it does require a level of risk tolerance, confidence in the business and team, and a longer total investment cycle than is generally prevalent in the Indian venture ecosystem.
By and large, Indian venture investments term sheets specify a five year horizon for the return of capital, which is usually adequate for a software play, but in many cases will not be adequate for a product or technology company.
As a result, entrepreneurs pitch businesses that fit the prevailing investment climate. Being brazen enough to walk into an investor asking for crores of rupees, two years of development time and a 7-10 year investment horizon is perceived to be not an proposition in which many will invest and is therefore not the norm.
The usual pitch is a version of "We have this idea that we have worked on for the past few months, and here is the prototype. With another few lakhs of rupees invested, we can finish the product, show product-market fit, and in the next six months to a year raise a bigger round of funding together."
Until the Indian venture ecosystem increases the risk profile and investment horizon a few years, it is hard to foresee large technology-based product companies being produced, at least from the startup ecosystem.
(Jayant Kadambi is entrepreneur, technologist, and business leader who led his most recent company, YuMe, to an IPO as a global leader in digital media technology. Jayant is based in Silicon Valley and is spending his time as an advisor, board member, and angel investor.