india internet opportunity -...

1 India Internet Opportunity

MAY 2017

India Internet Opportunity

May 2017


India Macro and Consumption

India took the path of a socialist economy after independence in 1947. The policies tended

towards protectionism, strong emphasis on import substitution, state regulated industrialization

and a dominant public sector. But India started having large fiscal deficit problems since 1985,

and by the end of 1990, it was in a state of serious economic crisis. The government was close to

a default and foreign exchange reserves had reduced to the point that India could barely finance

three weeks’ worth of imports. The country ran into the risk of precipitating into an era of

economic crisis, unemployment, despair and civil unrest - in contrast to the hope and confidence

we enjoy today of becoming a superpower by 2030.

Making a bold and uncharacteristic move, on May 21, 1991 India airlifted 60+ tons of gold to be

sent to Bank of England and Union Bank of Switzerland. Govt. of India had to take a loan from

IMF and as a condition had to “liberalise” the economy. This pivot etched 1991 into the

cornerstone of the great Indian economic turnaround, ushering-in unprecedented economic

progress. This remarkable story has been captured in several notable books. Gurcharan Das, in

India Unbound, remarks, “Although slow, hesitant and incomplete, 1991 reforms set in motion a

process of profound change in Indian society. It is as important a turning point as Deng’s

revolution in China in 1978”.

As of 2016, India is not only the 7th largest economy in world, but it is also growing faster than

its peers like China. By 2025, India is expected to surpass Germany and become the 4th largest

economy. That India is the last standing beacon of hope amongst the emerging markets, found

resonance at 2016 WEF Davos.

Source: World bank, OECD

Economic growth aside, India is also set to reap what is now famously called the demographic

dividend, with its working age population being larger than the population that is dependent on


it. Today, India’s 65% population is below 35 years of age. With Western Europe, the US, South

Korea, Japan and even China’s aging population, could this demographic dividend offer India an

edge? As per IMF, it could add a significant 2% to the GDP growth rate of country.

World-class infrastructure, deeply rooted education systems, and pro-business government

policies among other things that define the economic progress of Europe, North America and

even the shining cities of China, are often considered lagging in the country by foreign visitors.

Frequent instances of friction between governments and industries further bring forth investor’s

concern on growth and capital risk. Govt.’s misguided tax fight with Vodafone in 2011 and West

Bengal’s tussle with Tata’s for the Nano project are two prominent examples. On the other

hand, the government never regulated the country’s IT industry, because it never fully

understood its potential. As a result, that sector flourished. A book by Gurcharan Das captured

this phenomenon in its very title: India Grows at Night.

Fortunately, the environment is changing fast, business friendly outlook and initiatives of the

Modi government is set to make the India’s economy bigger and better again. Today, India can

grow during the day too, while the government is wide awake.

Consumption Class is Growing Rapidly

Rapid economic growth has pulled millions of people out of poverty and created a sizable

consumption class. In 2015, 66M households were part of the ‘consumption class’ with annual

household income of more than $4000, which is 27% of India’s total household. This class

constituted only 7% households back in 2005.

As India continues the path of economic development, the consumption class will rise to 53% of

total households in 2025, implying a mammoth 800M+individuals belonging to the consumption

class. Another important point to be noted is the expansion of the affluent class (Globals) from

2.5M households in 2015 to 23M by 2025.

2015 real prices, Source: NCAER, McKinsey


85% of the consumption class lives in Urban areas. Urban population in India, unlike China, is

spread across a large number of cities. Only 1/3rd of the urban population lives in metropolitan

(top 7) cities. Remaining 2/3rd of the urban population lives in 400+ Tier-II & beyond cities.

Non-metropolitan cities, consequently, will play an important role in India’s consumption story.

As Indians continue to climb the economic ladder, the composition of their spend will also

change considerably. Today, a typical household in the country spends ~45% of its income on

food, clothing and housing. In fact, food and clothing account for 70% of the total retail

expenditure in the country! As witnessed in developed economies, discretionary spend will

take up larger share of nation’s shopping basket as national income rises. For example, food (as

% household consumption) reduces from ~40% for Aspirers, to ~30% for Seekers, to <10%

for Globals. As one grows richer, a higher chunk of income is spent on looking and living better.

Intertwined with the rise of purchasing power in the society and increased aspirations of the

consumer class, has been the rise of Internet in India. Formally first launched for the public in

1995, Internet penetration in India has reached a quarter of the country’s population. In the early

2000s, Internet was limited to households with computers or neighborhoods with cyber-cafes.

With advent of mobiles (specifically smartphones), India’s means of consumption,

communication and living is being fundamentally changed.

Smartphone and Mobile Data Revolution

Smartphone and telecom advertisements follow distinct narratives in India these days. A 70-year-

old is using Google maps to locate “must see” places on his vacation in Goa. A restaurant

waiter is learning English by watching YouTube videos in his free time. A 60-year-old nervous

mother visiting airport for the first time is being guided by her son via video chat. An illiterate

family taking pride in the progress made by their child in education through online interactive

tools. These narratives are not very far from the reality in India today.

Smartphone is probably the biggest platform shift in recent times. Globally 2B+ people are

carrying smartphones in their pockets and are spending 1.5-2 hours on it daily. This shift brings

limitless disruption possibilities. Riding on this shift, large consumer companies have been built

globally - Uber, Spotify and Airbnb to name a few.

India is a key participant in the global smartphone wave with the 2nd largest base of smartphone

users. In fact, India became one of the largest user base for some of the global internet giants

like Facebook, WhatsApp and YouTube in 2016. But long before global internet giants entered

India, one of the first major global technology company to enter the country was Siemens in

1922. Followed by IBM in 1977. But till the liberalization, there were very few multi-nationals

that took India seriously. Today, CEOs of most of the major multinational companies regularly

visit India, indicative of India’s market potential.


Declining smartphone prices and affordable prepaid plans along with nominal charges for

limited data usage has been a key driver for rapid penetration of smartphones in countries like

India. While Apple reimagined the smartphones in a way nobody could have thought, Android

changed the economics of smartphones by making their OS open source.

When erstwhile Rajiv Gandhi brought the PC to India in 1980s. It heralded a new era with the

great hope of changing life of Indians. But PC penetration was mostly limited to large

corporates. Even today less than 5% of consumers and SMEs own PCs due to the high cost of

ownership. With 300M users, smartphone has become the personal computing device of choice

across income classes and age demographics.

Source: IDC, Cybermedia Research : India Mobile Handset Market, Counterpoint Research, Statista

Average smartphone price in India declined by 35% from $200 in 2013 to $130 in 2016. At the

forefront of driving price disruption are Chinese companies who commanded 35% share of

smartphone shipments in Q1CY2017. Indian smartphone makers like Micromax, Intex and Lava

held the fort for a while, but recent entry of Chinese phone makers has eroded their market

share significantly. Within 2 years of India entry, Xiaomi has already become 2nd largest

smartphone brand by shipments.


Source: Counterpoint Research Market Monitor

While smartphone holds great promise, its true potential can be harnessed only if combined with

high speed (3G/4G) data connectivity. Despite having 300M smartphone users, India has only

120M 3G/4G subscribers. One of the key inhibitors has been the cost of data, which is at $3 per

GB per month. $3 is fairly high, considering the ARPU (average revenue per user) in India is $2.

The launch of Jio is already changing the game. Jio’s 4G data tariff costs $5 for 30GB data and

voice is free. In the first 6 months of launch Jio acquired 100M subscribers, rapidly taking the

market share away from incumbents. This is forcing other telecom operators to reduce the cost

of data and voice.

In most developed markets, telecom operators get more revenue from data than voice. In India

telecom players get 50% of revenue from voice and 20% from data. But in the next 3-4 years this

balance will reverse and data will become a major contributor to the topline. It is estimated that

500M subscribers will consume average 10GB data per month as compared to 120M subscribers

consuming average 1GB data per month in 2016. This is 40x increase in total data

consumption.


Source: Quarterly reports of Indian telco (Airtel, Vodafone, Idea, Aircel),

Reliance Jio Investor presentation, E&Y Future of Digital Content India, Jan 2016

The 4x increase in 3G/4G connected smartphone users and 40x increase in data consumption

will open massive opportunities for consumer internet companies. Depending on the sector - e-

commerce, digital media or financial services - companies will still be required to solve India

specific challenges. But a strong foundation is being laid through rapid smartphone and 3G/4G

mobile data penetration for internet economy to thrive.

E-tail: Current State and Way Forward

India presents a curious case when it comes to retail. At $630B in size, India is among the top 10

retail markets in the world. However, this huge market is still largely unorganized with modern

retail commanding a rather small market share of 10%. With 14M retail outlets, India has one of

the highest number of outlets per person (11 per thousand).

It’s been a decade since India embarked on the journey of organized retail, but it has not yet

been able to make its mark beyond the metropolitan cities. The sector had been stifled by archaic

FDI policies till recently. Despite being one of the largest sector in the country, only in 2006

India began to open retail for FDI. Even then, it allowed up to 51% ownership only in single

brand retail. China in contrast has allowed 100% FDI in both single brand and multi-brand.

In 2011, the next phase of reforms took place allowing 100% FDI in single brand retail and 51%

in multi-brand retail. But these reforms were accompanied by few complicated conditions. Eg:


Single brand retailer should source 30 percent of its goods from India. All multi-brand and single

brand stores in India must confine their operations to 53-odd cities with a population over one

million. Multi-brand retailers must have a minimum investment of US$100 million with at least

half of the amount invested in backend infrastructure.

Modern retails under penetration is also driven by poor economics, lack of adequate affordable

rental space and capex requirements to scale.

In Tier-II and beyond, ~94% of retail sales still happen through unorganized retail

shops.

Source: McKinsey iConsumer China 2016 Survey, IBEF, Knight Frank – Think Retail 2016

Today, E-tail is ~2.5% of the retail market. In China and US, E-tail is 13% and 8% of their retail

markets respectively. The excitement for entrepreneurs is palpable, given the large opportunity

that exists to deepen the roots of e-tail in India.

Internet holds the promise to fundamentally change the way consumer aspirations and service

needs are addressed. Foundation has been laid in form of rapid expansion of digital

infrastructure across our cities and villages. Expectedly, digital infrastructure has made significant

inroads into Tier-II & beyond towns at a rate much faster than its physical counterpart.

E-tail, a $15B market in 2016, was almost non-existent in 2012. From 2012 to 2015, it went

through a rapid market creation phase - growing at more than 100% YoY. In 2016, sales top 3

E-tail players combined has already surpassed the sales of top 3 offline retailers. But it is still a

nascent and concentrated market where 70% of sales comes from top 7 metro cities and 65%

of sales comes from a single category - Electronics.


Source: Redseer Consulting - E-tailing Revolution in India

As E-tail market enters the next phase of growth, following needs to happen:

● Expand shopper base beyond metro ● Increase online share of non-electronics retail spend

Shopper Base Expansion

Tier-I constitutes only 10% of India’s population and 20% of retail sales. For E-tail to expand

the shopper base, it needs to go beyond Tier-I cities. In China, Tier-III & IV cities contribute to

50% of E-tail sales. In fact, it is believed that E-tail generated 40% new consumption spend in

Tier-III and IV cities in China, as those parts of the country never had access to such a large

assortment of products before.

As E-tailers embark on the journey of getting to the next 200M shoppers, there are a few

nuances that makes these next 200M shoppers different from 60M early adopters.

English is not a dominant language

India has only 125M people who can read/write/speak English. As one goes beyond Tier-I, the

non-English speaking population will form a sizable share of target consumer class. Is also

believed that more than 90% of India’s new internet users will be non-English speaking.


Most e-tailers don’t have a strong regional language offering. These users may occasionally buy a

thing or two online when available at discounts. But to drive a behavioural change and gain

sizable share of their wallet, it is important that users are engaged with E-tail platforms in the

language of their choice. These users would find it difficult to comprehend product descriptions

and user reviews written in English.

Unfortunately, it is not a simple translation problem. The language most people speak on daily

basis is very different from the pure form of language that most translation engines are trained

on (see the example below)

Most Hindi speaking people will not understand the product description as translated by Google

translator above. Adding to the challenge, E-tailers also have little control over the content.

Product content is uploaded by sellers and reviews by users.

For E-tail to expand beyond the large cities, E-tailers need to make concerted efforts towards

serving the regional language users.

App retention is challenging

Affordable smartphone (sub $100) segment has 50% share of total smartphone shipments in

India. These affordable smartphones typically have 8GB memory. Large share of next set of

online shoppers will be users of these affordable smartphones.

8GB capacity in today’s era is like using a computer with 512MB RAM. With Android OS

footprint getting bigger and increased usage of high definition media, typically 85% of 8GB

capacity is occupied by OS, Whatsapp and Media. With 1.3GB memory left for third party


apps, these phone users have only 6-8 third party apps on the phone. This is a huge

challenge for any internet company. Average 90 days uninstall rate for these 8GB phones is 80%.

Until a frequent usage behaviour is established, app retention will be incredibly difficult.

Source: Frost & Sullivan

While it is good to have an app strategy, but it cannot be the only strategy. Having responsive

and engaging mobile web interface is going to be critical. Various other approaches are being

taken, including chat commerce and single app interface for multiple apps, to solve the app

retention problem.

Category Adoption Beyond Electronics

India E-tail today probably looks like any other E-tail market in its nascent days, where

standardized product category like electronics has a significant share of the market.

Source: Statista, Digitalcommerce360, China Internet Watch, Kalaari Estimates

As market evolves, other categories will witness growth in online adoption. Although various

categories will go through their own natural adoption curve, E-tailers have opportunity to play a

role in accelerating the pace of adoption through technology and value delivery innovations. For


example, online grocery player Yihaodian in China has set-up 1000 AR enabled stores in parking

lots, parks and in front of famous landmarks. It helped the company take advantage of high

footfall at these places for customer acquisition, while continuing to be a pure online player.

Source: Kalaari Estimate, CII-BCG Study - “Retail transformation: Changing Your Performance Trajectory”

Driving higher online adoption of non-electronics is not only important for the growth of E-tail

market but also critical for favorable economics. Electronics is a low margin and discount driven

category. First time shoppers probably will start with buying electronics online. It is then

important that E-tailers can retain those consumers, build loyalty and get higher share of their

wallet spend. In developed E-tail markets like US and China, electronics has only 16-17% share.

Foundation has been laid in the form of digital infrastructure. E-tailers’ ability to innovate to

serve the next 200M shoppers and drive higher online adoption of non-electronics categories


will be the key to the growth of E-tail market.

Our Learnings

Having significant investment into the e-tail sector, we’ve got our own set of experiences and

learnings. Following are a few key learnings:

● For high involvement categories such as Furniture, Fashion and Jewelry, having offline

presence will be necessary to build brand and trust among consumers.

● Except electronics and fashion, all other categories are still in market creation phase with

<2% online penetration. Market leaders will be required to make significant investments

to drive large scale change in consumer behavior.

● Mobile will drive majority of E-tail sales. Optimizing mobile experience (especially

mobile web) for each customer touch point including navigation, search & filter, product

page and payments will be critical to drive conversion. Conversion rates for Indian e-tail

player are abysmally low, improving product experience will be key part of the strategy to

drive higher conversion and lower acquisition cost.

● Even within established online categories such as Electronics and Fashion, new models

will emerge to cater to different consumer segments and needs - Rentals, Internet first

brands, Offline to online, Social and Content commerce, Luxury goods among others.

● Cost of customer acquisition is high for most segments fueled by hyper competition.

Building loyalty and driving high customer lifetime value will be important for

sustainable growth. Relentless focus on customer experience and KPIs such as NPS and

Repeats will be important operational metrics to track for companies and investors.

Amazon prime is a great example of customer stickiness and loyalty building.

● CoD was an important innovation to fuel the growth of e-tail, 60% of e-tail sales happen

through CoD. But it is also believed to be one of the key reason for high return rates.

For most e-tailers return rates are in range of 15-25%. With UPI, Aadhaar and Bharat

QR share of of digital payments need to increase. It will be critical to bring down cost of

managing cash, reverse logistics and excess inventory.

We continue to be bullish on the sector, and believe it holds strong long term potential.


Digital Payments

India has traditionally been a cash heavy economy. Cash to GDP ratio is one of the highest at

12% and this has been a huge burden on the economy. Cash has given rise to a shadow

economy, which is estimated to be ~30% of GDP. Foregone tax on shadow economy is ~3% of

GDP and cost of managing cash is 1.7%. So overall, cash is costing India almost as much as

the country’s fiscal deficit.

When it comes to adopting a dominant mode of digital payments, we have seen examples of

countries taking different paths. Debit/Credit Card is the dominant digital payment method in

the US with almost 100% card penetration. However, mobile wallets dominate in China due to

low card penetration. In 2016 China mobile payments volume stood at $3.2T as compared to

$212B in US.

Riding on the dominant payment method, large tech companies were created. In US, it was

Stripe riding on card penetration, while in China it is Alipay and Wechat pay driving 90% of

mobile payments volume.

India is still nascent for any form of digital payment. While debit card penetration is high,

number of average POS transactions per debit card per month stands low at 0.3-0.4. And 85%

of debit card transactions in value terms are ATM withdrawals. One of the key reasons for such

low debit card POS usage has been low POS penetration.

Source: RBI

While India has ~14M retail outlets, there are only 2.2M POS terminals. India has one of the

lowest POS per 1000 debit cards ratio at 2.4. The ratio is 13 in US, 14 in China, 33 in Australia

and 15 in Brazil. According to RBI estimates, India needs 10x more POS terminals to sufficiently

serve the current card user base.


In Nov 2016, Indian government took a game changing policy decision of scrapping 86% of

India’s currency to curb shadow economy and drive aggressive digitization of payments. A large

uptick in both forms of digital payments – cards and mobile wallets - is visible due to

demonetization. Both modes of digital payments – cards and mobile wallets – will continue to

witness growth due to very low digital payment penetration.

Source: RBI

But something else happened in 2016-17 which will play a pivotal role in defining which way will

India go when it comes to the dominant mode of digital payments. The answer is probably going

to be neither cards nor mobile wallets. It may be a government led mobile payment system based

on Aadhaar + UPI (Unified Payment Interface) + Bharat QR + BHIM (Bharat Interface for

Money).


The progress made by government in the direction of making it a default payment system has

been unprecedented:

● 1B Aadhaar cards have been issued in 5 years.

● 250M Bank accounts were opened under Jan Dhan Yojna in the last 3 years. This is 50%

of the total 500M bank accounts in India.

● BHIM (UPI based mobile payment app) was launched 7 weeks from announcement of

demonetization. The app has had 18M downloads within 3 months of launch.

● Launched Bharat QR as a standard QR code for merchant payment acceptance. Target

to get 10M merchants to accept UPI payments through Bharat QR in 12 months.

Source: NPCI

Having launched six months back, UPI is driving transactions worth ~$300M per month. In

value terms UPI payments have already reached 30% of mobile wallet transactions and 3% of

card transactions. Although 80% of current UPI payments are P2P payments, once Bharat QR is

rolled out, merchant payments are expected to form the significant volume of UPI transactions.

Although these are nascent days of UPI transactions, it will not be surprising if UPI surpasses

cards and become dominant mode of digital payments in the next 18-24 months. 2016-17 will

probably go down in history as the year that changed India’s payment landscape forever.


Conclusion

The story of India’s internet story is yet in its 1st chapter only. It has already begun to catch the imagination of entrepreneurs and investors both domestically and globally. The market so important that global internet players are entering with the motto of winning it whatever it take. Indian players will continue to face fierce competition from global counterparts with advantage of global learnings and access to large pool of capital. To fight out the battle, Indian entrepreneurs will require access to large source of growth capital and management talent pool capable of taking

ABOUT KALAARI CAPITAL

Kalaari Capital is an early-stage, technology-focused venture capital firm with $650 million in assets under management. Since 2006, we have empowered visionary entrepreneurs building unique solutions that reshape the way Indians live, work, consume and transact. Along with capital, we focus on long-term partnership with entrepreneurs to help unlock large value through disruptive innovation.

AUTHORS

Vani Kola

Darshit Vora

SUPPORTED BY

Naman Narain

Vinod Shankar © May 2017 Kalaari Capital Advisors. All rights reserved. The Report has been complied for information purpose only. The Report is based on current public information that we consider reliable, but we do not represent it is accurate or complete. The information, opinions, estimates and forecasts contained herein are as of the date hereof and are subject to change.

`

https://www.linkedin.com/in/vanikola/

https://www.linkedin.com/in/vanikola/

https://www.linkedin.com/in/darshit-vora-92a3606/

https://www.linkedin.com/in/darshit-vora-92a3606/

https://www.linkedin.com/in/namannarain/

https://www.linkedin.com/in/namannarain/

https://www.linkedin.com/in/vinodshankar1/

india internet opportunity -...

Documents