Hidden costs of starting up a business in India
A version of this article first appeared on the VCCircle blog here
It has now been 3+ years since Canvera got started and we have in this time grown to ~500 people across 8 offices. Needless to say this has been a phenomenal journey where we have serviced the needs of thousands of professional photographers (and by extension 100s of thousands of consumers) all over the country. In fact, there probably is no better time to start a business in India: growing domestic consumption, investment in infrastructure etc; there is just so much to be done for India to make the transition from an emerging economy to a developed econmy. I get asked a lot about some of our learnings through this time and in this post I am going to share a key one about costs of getting a startup off-the-ground in India.
When I look back at some things we got right and the mistakes we made, one very early decision stands out as being crucial. After our study of the Indian Photography landscape Peeyush and I concluded that we should either raise $1.5M in our first round of funding or not do the business. We came to this conclusion by modeling the operations of the business to get to the next meaningful milestone and realizing what all we’d have to build in order to get there. We were extremely lucky that Josh Bornstein of Footprint Ventures bought this argument (what were you thinking, Josh? 😉 ) and then Mohanjit Jolly of DFJ (and you too, sir!) followed suit. Our first round of funding, our seed round, ended up being a $2M round. Yes $2M – I don’t know of too many cases where this has happened. And boy was that critical for our present traction. Silicon Valley type early stage investing requires raising a little bit of capital, building prototypes, getting some early customers and then going for an institutional round. There are a lot of infrastructure related issues that are implicitly taken for granted in developed markets to make this possible. But in my opinion there aren’t enough examples in an emerging market like India. I have come to realize how expensive India is for early stage investing for PRODUCT companies (I think slightly different rules apply to services companies).
Here is the punch line: What makes early stage investments expensive in India for product companies is the inability to buy products, services and infrastructure on a purely variable cost basis and at reliable quality levels in order to do micro-experiments in the development phase of the business. To visualize this difference between developed and emerging markets look at this graph (this is of course an oversimplification but good enough for the point I am trying to make):
What this says is that before you even get started you have to invest a lot in building out the company’s operating eco-system. Let me illustrate this with some examples that we have seen at Canvera:
- ELECTRICITY: Canvera has some very expensive high-end digital printers but in order to keep them running we had to buy one of the most expensive UPS units available in the world because the primary attractive feature of this UPS unit was that it “cleans up” the poor quality of electricity for these high end printers without which the electricity would damage the printers. In addition we had to put in place a DG backup as well. This is the fixed cost of electricity even before we got started.
- CREDIT INFRASTRUCTURE & LAW ENFORCEMENT: Canvera has eight offices and for each of them we’ve had to make significant deposits with the landlord. The primary reason for doing this is that at a basic level a landlord can’t rely on either a credit system or law enforcement to enforce the contract in case of issues so s/he protects himself/herself upfront. This is capital locked up that could go into product development.
- COLLECTIONS: With only 20-25M credit cards (and no growth in the numbers), India is still a primarily cash economy. But more than that consumers don’t as yet trust electronic payments. The net result for a company like Canvera is that we’ve had to develop our own collections network through a combination of on-the-ground sales, regional offices, relationships with banks & payment gateways, custom software development and custom processes for reconciling payments. It has now been 3 years (and counting) on this effort and while this has been critical for the growth of the company, we still don’t have the scale, cost and reliability of a payment gateway that an early stage company in developed economies can simply plug into (side note: Square has further lowered the entry barrier for small businesses in the US and is growing at a phenomenal rate). I view all this as capital and effort that did not go into core product R&D.
- HIRING: In one of our largest groups in the company our average hiring ratio is 30:1! We work with a number of staffing companies but the poor quality of resume screening, mis-aligned interests, fraud in application forms etc forces us to hire a set of screeners who pre-qualify candidates and then we put them through vigorous time-consuming interviews. Once candidates join we put them through training and even after all that we end up letting go a number of people. This is all significant upfront cost, both in dollars and in opportunity, that I’d much rather not have to pay
- ACCESS TO AFFORDABLE DEBT: In most cases banks in India are averse to giving debt/credit even for equipment financing where collateral is available. They typically require 3 years operating history & profitability. We were fortunate that most of the equipment we needed was from HP and we were able to get financing from HP Financial Services but relative to terms a company with venture funding can get for equipment financing in the US our terms were much worse: much higher down payments, very high interest rates. Of course it was better for us to take the financing than not but a lot of startups I know in India are forced to pay full price up front. That is a very poor use of capital.
There are many more such examples. On one hand there is no question about the long-term prospects of the Indian economy and the excitement in being part of the transition of the country from an emerging to a developed economy. At the same time, I would encourage entrepreneurs (and investors) to carefully consider some of these issues when deciding a funding and execution strategy for their particular businesses. In my opinion there are many meaty problems to be solved in India, but a lot of them may need homegrown thinking. If you are an early stage entrepreneur facing this dilemma about the quantum of money you require early on to develop a business in India, give Josh/Mohanjit a call – they understand this issue very well.