India: Endangered Entrepreneurship Ecosystem
By: Lily Liao & Jitesh Vyas
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
Over the last decade, India has attracted over $84B US in private equity with only a third of these investments showing a positive return. As a result, private equity firms’ exposure to Indian investments has decreased by 31% since 2011, and in some instances, firms have pulled out of India entirely . On the other hand, venture capital firms have set aside $5.8B for the purpose of investing into Indian start-ups over the past four years, of which only 10% have been successfully invested into emerging businesses. This clearly shows how a large portion of investment dollars that were once available to entrepreneurs are now being allocated to other investments.
To address the combined issues of declining investor confidence and emigration of India’s talent overseas, the newly elected Prime Minister of India, Narendra Modi, has proposed a “Smart Cities” initiative. Smart Cities could benefit India by developing crucial infrastructure; however, the initiative is poorly-timed and the benefits are largely theoretical. If Modi’s goal is to regain investor confidence, solve brain drain, and better utilize human capital – India should instead look to invest in the groundwork for a sustainable and pro-entrepreneurship ecosystem. This will attempt to jump start India’s once impressive GDP growth rate, which has fallen from 10% in 2010 to 5% in 2013.
Smart Cities
A Smart City is a municipality that uses digital technologies to improve urban processes such as transportation, water distribution, waste management, and energy systems. Given the rapid urbanization of India, Smart Cities are seen as a way to drive urban development, job creation, and economic growth while improving living standards. The hope is that with increased opportunities in urban centres and a more innovative and technology-driven environment, India’s brain drain will also slow down. The current plan is to build 100 Smart Cities at a cost of $1.2T over 20 years. The Government of India has so far allocated $1.2B in 2015 – or a mere fraction of the total cost – to start the development of Smart Cities in the Delhi-Mumbai Industrial. It is safe to assume that Modi sees this project as a foreign investment opportunity in India; however, this seems infeasible given the large sum of inflows which are required to fund the project and the slowing private capital market.
Modi justifies the feasibility of the Smart Cities initiative based on the success of similar initiatives such as Malaysia’s Smart City in Kuala Lumpur. In reality, these two projects are quite different. Malaysia has ideal conditions for a smart city and its expansion by 2020 is expected to produce a sustainable real GDP growth rate into 2050 of 5.8%, as well as attract $444B in foreign investments. In contrast, India’s economic and demographic profile does not match these ideals. Delhi still has at least 20% of its residents living in “identified” slums despite having the highest per capita annual income of $3,254 – only 18% of Kuala Lumpur’s. The Smart Cities concept works best in service sector dominated areas where digital technologies add the most value, exemplified by Kuala Lumpur where their service sector represents 83% of their economy. Chandigarh and Delhi are two state-cities where the service sectors are 85% and 82% respectively, however the remainder of India’s 27 states average a service sector size of only 49%. A poor fit exists for Smart Cities in most of India where the majority of states are still heavily focused on agriculture and industrial manufacturing.
In order to have a successful Smart City implementation in Delhi, a high level of involvement from the government is needed for successful public-private partnerships. These efforts have historically failed in India, particularly with infrastructure. For example, the failure of a public-private partnership in the Mumbai metro project led to a four year delay in its completion and doubled the cost from $382M to $697M. Other infrastructure failures include the new expresstrain in Delhi and the new power plant in the west of India – all poor precedents for the success of Smart Cities.
Brain Drain Phenomenon
Brain drain is the movement of highly skilled and qualified people from one country to another, often for the purpose of better working conditions and higher salaries. The Government of India estimates that there are currently 30M highly skilled people of Indian origin who have left the country to work overseas. The emigration of computer experts to the United States alone results in a loss of $2B a year for India. This suggests that India has difficulty retaining top talent, stemming from issues with its education system and a lack of employment opportunities. Students are discouraged by high entrance cutoff grades that near 100% at the best Indian post-secondary schools, and choose to go abroad instead. The Indian Institute of Management-Bangalore found that students pursuing postsecondary education abroad has increased by 256% in the last 10 years. These students then tend to stay in these countries after being exposed to better wages, facilities, and a better quality of life.
Better Opportunities in Entrepreneurship
The best strategy for India to jump start its economy is to invest directly in its entrepreneurial ecosystem. Though India has the spirit and propensity for entrepreneurship, the country lacks the ability to organize the resources to run successful startups. Resources such as management assistance, financing, and shared office spaces are commonly available to entrepreneurs in both the US and India, however the US has a long-term new business failure rate of 65% compared to India’s at 90% .
The major gap in India’s entrepreneurial ecosystem is product commercialization. Many start-ups fail since there are few established incubators which support them in bringing prototypes to market. Currently, there are only 120 incubators for all types of entrepreneurship in India and they are all sponsored by the government and affiliated to educational institutions. In comparison, the US has 178 incubators specialized in technology alone; all sponsored by different venture capital, university, corporate and government organizations. To improve its startup success rate, India will need to model its venture incubation programs similar to the US and provide better resources to its entrepreneurs.
Countries with strong entrepreneurship ecosystems, such as the U.S. and Israel, have fewer issues in bringing products to market. Tel Aviv’s entrepreneurship ecosystem flourishes due to a strong focus on networking, risk taking, and government support. The US government recognizes the importance of entrepreneurship to the economy, and is showing fiscal support through two $1B funds from the Small Business Administration to match private venture capital invested in high-growth companies.
A Step by Step Guide for India
Incentivizing Mentorship
Indian high-skilled immigrants made up 64% of 2012 US H-1B work visas. Retaining these bright individuals is the first step in India’s entrepreneurship action plan. To achieve this, the Indian government needs to directly reach out to both successful Indians in India and overseas in order to strengthen its mentorship network. The goal is for mentors to provide new entrepreneurs with guidance and help them network in exchange for a small equity percentage in their companies. With proper mentorship, more incubated start-ups can become investment grade and attract investment and support from overseas.
Providing Computing Power
India’s IT industry is poised for growth, given that in 2013, 69% of all new start-ups provided some form of web service. The market size for outsourcing digital technologies to India for social, mobility, analytics, and cloud (SMAC) is set to increase by a compound annual growth rate (CAGR) of 21% into 2016, with the total contracts valued at $287B. The government needs to support entrepreneurs and help them deliver on the large opportunity to meet the demand for IT services. The concept is called “Cloud-Sourcing” – a term conceptualized by Canadian company Cybera – offering 0.5TB of Rapid Access Cloud in order to enable Calgary start-ups free cloud computing resources. Cloud infrastructure stands as one of the largest costs for a web service company. For perspective, a simple 10 user network could cost between $5,000 and $12,000 annually in the US. The data centre strategy is to reduce the amount new companies need to gather funding, validate ideas, and create prototypes. By lowering the barriers to entry in IT, more entrepreneurs can test their ideas, ultimately increasing the number of successful start-ups. A capital budget was developed to determine the cost of developing a data centre to meet the requirements of new tech companies over the next ten years. The number of tech startups is projected to grow in India by 25% annually. For the first five years of the project, $45M is required to construct the data center with total maintenance costs of $67M. Calculating a present value of the 10 year project, India will invest $465M of the $1.2B earmarked for the Smart Cities initiative in a central data center to house data for start-ups, completely free.
Building Incubators
Incubators help start-ups survive the early stages of development when they are most vulnerable. A great example of a successful incubator program is a recent ongoing initiative spearheaded in India by NASSCOM, called 10,000 Start-ups. The most recent session took 9,000 applicants and 16% were deemed investment grade. With support from Google, Amazon and Microsoft, this incubator in Bangalore supported a cohort of 150 companies and provided them with $25,000 each in accelerator support, mentorship and angel funding. The $735M balance of the Smart Cities budget should fund projects of this nature and other incubators for a variety of industries. Assuming a conservative per start-up cost of $30,000 similar to the 10,000 Start-ups program, over 24,000 grants could be awarded. Considering India’s current business success rate of 10%, 2,400 impactful businesses can be started. As more new companies work with incubators, the success rate could easily double.
Increasing the effectiveness of entrepreneurship is important for India’s socio-economic development. In 2012, Endeavor reported that the average high-impact entrepreneur generates 30 more jobs than the average comparable company. Investing in entrepreneurs will have tremendous economic impact for India. The government can add hundreds of thousands of new jobs in high growth industries.
The Key to India’s Long-Term Success
By developing a mentorship network, providing free data solutions to start-ups, and building more successful incubators programs, India has the potential to sustainably grow its economy. In doing so, India can once again produce investment grade start-ups and attract venture capital funding sources. This will create a new and exciting market for foreign direct investment in India. Instead of investing in an overly ambitious Smart Cities initiative that is poorly timed and highly risky, Modi’s priority should be to improve the existing entrepreneurship ecosystem and raise the living standards of the nation as a whole.
