The cycle, however long, eventually turns. And turned it has, in India. The startup ecosystem which has been in overdrive for the past few years — propelled by a combination of factors, but largely, by the era of cheap money — is now showing signs of weakness. And with this turn comes the realisation that many of the assumptions that underpinned the stratospheric valuations were unhinged from reality.
It was hard not to be swept by the allure and promise of the new age tech companies. Built on a compelling narrative — the combination of accelerated financial inclusion (bank accounts), ease of identification (Aadhaar) and connectivity (mobile phones) — it is ultimately a bet on the Indian consumer, and the economy, not on government regulations/policies. In the era of cheap money and negative real interest rates, uncomfortable questions over the true market size and profitability were swept under the rug. High cash burn rates were the norm as both startups and investors sought growth by subsidising the customer.
But profitability is not just an arcane concept that belongs to another century. Among the startups that have gone public in recent times, Paytm’s losses stood at Rs 2,396 crore in 2021-22, while for Zomato and PB Fintech (PolicyBazaar) losses were Rs 1,222 crore and Rs 832 crore respectively. The seemingly inexhaustible source of cash that funds such losses is now being squeezed. Sure, investors will continue to pour money. Some early age start-ups will continue to be funded, as will some of the more mature ones. But investors are likely to be more circumspect in their dealings. This will include the entire range — from early stage venture capitalists to institutional and retail investors — all of whom have made money, but have also burnt their fingers.
Recently, Alibaba and Ant Financial exited their entire holdings in Paytm Mall for Rs 42 crore, valuing the venture at a mere Rs 100 crore — a far cry from the $3 billion valuation ascribed to the company in its last fund-raising round. There are also reports of startups in diverse markets, ranging from Ola to OYO, planning to raise funds at lower valuations. Among those who have gone public in recent times, most are trading much below their listing price.
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During the heady days, many numbers, indicators of the size of the market or TAM (the total addressable market), were bandied about. One such number thrown around is the smartphone users in the country — some have pegged this at 500 million. Or the transactions routed through the UPI platform — in May there were almost six billion transactions worth Rs 10 trillion. Or the near universality of bank accounts. But in reality, for most of these startups, the market or even the potential market is just a fraction of this. Whichever way one slices the data, the reality is, there aren’t that many consumers with significant discretionary spending capacity, and those with the capacity aren’t increasing their spending as these companies would hope. This seems to be the case across startups for a range for products/services.
Take Zomato, for instance. In 2021-22, 535 million orders for food delivery were placed on the platform. Considering that the company has 50 million annual transacting consumers, this translates to just under 11 orders per customer for the entire year or less than one order per customer per month. Of these 50 million customers, only 15 million transacted at least once a month, while 1.8 million did so once a week. In the case of Nykaa, the average monthly unique visitors range from around 16 million for the fashion vertical to 21 million for the beauty and personal care products. However, the number of transacting customers is only 1.8 million and 8.4 million respectively. Similarly, while Policy Bazaar has around 59 million registered customers, only 11.8 million are unique purchasing customers.
What is equally worrying is the complete absence of any increase in spending by even these consumers who would have the capacity to spend more. In 2020-21, the average order value on Zomato was Rs 397. In 2021-22, it was Rs 398. In the case of Nykaa, the average order value in the beauty and personal care vertical was Rs 1,732 during January-March 2022 — the lowest it has been in the last eight quarters. In the fashion category, it was almost flat compared to the same period last year. In the case of PolicyBazaar, the situation isn’t any different.
While more consumers are on-board digital payment platforms — Paytm has about 70 million monthly transacting users — these numbers suggest that when it comes to consumers with considerable discretionary spending, the size of the market shrivels considerably. While these companies have seen an increase in the number of transacting customers, to what extent the overall customer base for these startups can expand further is constrained by the number of households in the cohort that has significant spending power. And if sales of small cars, a marker of an increase in discretionary spending, a sign of ascendancy to the ranks to the middle class, aren’t growing — sales of Maruti Suzuki’s mini and compact segments, which account for roughly two-thirds of the car makers domestic sales, actually contracted in 2021-22 — then it is perhaps the clearest indication that the market just isn’t expanding. The macro reality is catching up.
Tighter financial conditions, a re-rating of the market, will impact both fundraising efforts and valuations. Several questions arise. To what extent will investors continue to subsidise consumers? Will startups still command the same valuations they have received in previous fundraising rounds? Or will we see down rounds? Some startups will survive this period. Many may not. And changes in the dynamics of private markets will also have a bearing on public markets.
Intriguingly, though, even as questions over the prospects of startups, consumers, and the economy are being raised, valuations of some companies in sectors more tightly regulated, more directly influenced by government policies, seem to defy gravity. For some of these companies, the price-to-earnings ratio is even higher than the astronomical price-to-rent ratios of residential real estate in Delhi.
This column first appeared in the print edition on June 28, 2022 under the title ‘On startups, a gravity check’. Write to the author at firstname.lastname@example.org.