Why Are Indian Startups Imploding?

A pedestrian walks past an Oyo hotel, operated by Oyo Hotels Japan G.K., in Tokyo, Japan, on Monday, Jan. 27, 2020. Oyo has drawn particular attention in SoftBank Group Corp.s portfolio of startups because of its similarities to WeWork. Both are trying to change traditional real estate businesses with technology. Both have charismatic young founders. Now, skeptics say Oyo could also fall short, further undermining Sons grand ideas about technology investing.

(Bloomberg Opinion) -- Indians have rightly been proud of the dynamism of our startups. Various government programs — Digital India, Startup India — are supposed to have energized the sector. Senior officials have insisted that “visionary and astute leadership” have “turned India into the [world's] third-largest startup ecosystem.” Prime Minister Narendra Modi has himself said that “startups are going to be the backbone of New India” and even formally designated a “national startup day.” (January 16, for all those who celebrate.)

In the cold, hard light of 2023, however, much of that enthusiasm seems misplaced, or at least overstated. By some estimates, 92 companies in the sector have laid off over 25,000 employees since the beginning of the year. Many that had planned to go public have postponed their offers and lowered their expectations of how much they hope to raise. Hospitality service Oyo Hotels, for example, reportedly reduced the size of its initial public offering to less than half of its original estimate of $1.2 billion.

In other cases, big financial firms have marked down the value of some of their investments by as much as half. There are fewer and fewer investors to go around — so much so that one recent networking conference descended into chaos when dozens of entrepreneurs turned up to find almost no investors in attendance.

It isn't entirely surprising that an industry so dependent upon open taps of cash from indulgent investors has run into trouble in a world of rising interest rates. By some estimates, the amount of funding for the sector fell 75% in the first quarter of this year, when compared to the same quarter in 2022. Late-stage startups looking for funding to scale up their operations have found it particularly hard to raise money.

Higher inflation also means that profit margins are declining — for those in the sector interested in making profits. As for the rest, inflation also undermined prospects for real consumption growth among their target audiences. It's hard to come up with optimistic scenarios for growth when your customers are at risk of being hammered by higher prices for essentials.

Indian startups have soaked up so much talent — and attention — that it is hard to imagine the sector will stay depressed forever. Even so, there are at least three lessons that we in India can learn from this downturn.

First, we shouldn't minimize the importance of remaining attractive to global risk capital. When global finance looks elsewhere, smart and ambitious Indian companies are left with far fewer options.

Not all sectors can be pumped up by existing institutions or public money. It's now being reported that — rather absurdly — Indian banks may have asked the central bank for a special funding line to be dedicated to startups. Hopefully the Reserve Bank of India ignores any such appeals. The risks that come with high growth should be borne by specialized arms of finance, not by state-guaranteed funds or banks. There are limits to what government can do.

Second, we should be realistic about the size and resilience of India's consumer market. While we may be the largest country in the world now, we won't be the largest market for a long while, if ever.

Some Indian startups sold sky-high expectations to their investors based on unrealistic notions of who could afford their services. Only a fraction of India's 1.4 billion people are consumers at the level of the global middle class. Indian fintech firms like to point to the near-universal reach of new payments platforms, for example. Yet only 6.5% of users on those platforms are responsible for almost half of all transactions.

India's domestic consumption market isn't large enough to justify the valuations of our startups, and it isn't large enough to grow our economy at the rates we need, either. Both India's startups and companies in the rest of the economy need to broaden their ambitions beyond the country's borders.

Finally, let's not assume that success is ours by right. Many of our best-regarded sectors — information technology-enabled services, generic pharmaceuticals, automotive components — contain fatal flaws or are in danger of being overtaken by technological, financial, or regulatory reality. The startup sector may at least be able to adapt quickly to changing circumstances. The same can't be said for India's other, creakier champion sectors.