Why India won't see a $100Bn internet company anytime soon

It appears to be a wonderful time if you are a reasonably successful internet company in

India.

First, there are more unicorns being created than anytime in the recent past. It looks like
practically everyone is getting funding in India. Companies are raising seed rounds of $40
million. In fact, the total funding raised by startups in India this year has exceeded the previous
year by a billion dollars. And we are still just in July.

Second, if you are an internet company that’s been around for a while, there’s an even
more attractive option—going public. Yes. For far too long, CEOs of Indian internet
companies have made promises and teased the idea of wanting to do an Initial Public Offering
(IPO), and finally, it looks like some of them have bitten the bullet. Zomato’s IPO is going live
next week. And there are reports of companies like Paytm*, Delhivery, and Flipkart who are
going down this path too.

Yes, it’s a wonderful time if you are a reasonably successful internet company in India.

You may ask, why is this happening right now?

Of course, there are many reasons. There’s a lot of liquidity in the private and public markets
right now—which is true. Others may argue that this was inevitable, and represents the
coming-of-age of internet companies, many of whom witnessed growth during the pandemic
or in the case of Zomato, Flipkart, Paytm, have been operating thanks to venture capital for
nearly a decade. This is the endgame. It’s here. It’s India’s moment.

All of this is true to varying degrees, but the actual reason is quite different.

It’s a secret that’s being whispered among some VCs, founders, and market researchers in
India. It’s something many people have noticed, but are somewhat uncomfortable talking
about openly.

And today, I’ll use it to explain why all of these companies are suddenly getting funded or
going public. And along with that, we’ll also see why India’s internet sector, which boomed for
over a decade with several companies going from smaller companies to unicorns and from
unicorns to decacorns, will likely never see a global pure play 100 billion dollar internet
company emerge anytime soon.

Here is the secret.

The number of active internet customers in India has stopped growing. This customer base
represents the total addressable market for most Indian internet companies. Until now, this
market was growing rapidly.

Now, this growth has essentially flatlined.

But if the number of customers has mostly stayed the same, then why are we seeing a surge
in funding for these companies? And why are some companies going public? Let’s dive in.

The Pyramid of Indian Internet Customers

If you are an internet company in India and a VC asks you what your addressable market
size is, you may be tempted to say that it’s 1.4 billion.

But that’s the population of India, he might counter.

So you may say, well, it’s the number of Indians with a mobile connection in India, which is a
little less than a billion. But not all of them have access to the internet. So you say, well, then,
it’s the number of people who have mobile data. Which brings it down to around 400 million.
But then that includes feature phone users, who can’t run most apps anyway. So you cut them
out. Then users who technically have a smartphone, but it’s a smartphone in name only and
can’t do much. Cut. Access to online payment mechanisms. Cut. Disposable income for
consumption. Cut.

Then we remove the ones who have used their phones just to do digital transactions like, say,
transfer money to each other or recharge their mobile plan. Also those who use it just as a
free media consumption device, like watching videos on TikTok or YouTube.

Cut. Cut. Cut.

After all of this, you’ll end up with an estimate of the number of annual active customers (AAC)
in India. These are the users who have access to the internet through a smartphone, use
mobile apps, have some disposable income, and have bought something online at least once
a year. E-commerce. Shopping. Food Delivery. Rides. Subscriptions.

This is the customer base of most Indian internet companies. These are the users who pay
for stuff online.

And how big is this group?

Well, if you really stretch it, it’s about 70 million users (realistically, it’s closer to 40-50 million,
but more on this later). That’s about the population of the United Kingdom.

There are empirical ways to validate this. A great proxy is the number of postpaid mobile users
in India, which is around 50 million, who form the bulk of this base. There are multiple reports
from a couple of years back which validate this 50 million number as well. Maybe it’s grown
since then to, say, 70 million users, but that’s more or less where the outer limit is today.
According to a source I spoke to, that’s also more or less the number of unique customers
who have bought a product at least once last year on the biggest horizontal e-commerce
platforms in India—Amazon or Flipkart.

Essentially, if you want to make money online in India, you’ll need to take it from these 70
million users.

Perhaps you may say that 70 million users is still a lot.

Well, let’s see. Broadly, these 70 million users can be broken down into three categories,
assuming it’s a pyramid.

Level C : India’s entry shoppers. At the lowest level, with the broadest base, comprising
roughly 40 million users.

These users are the ones who have bought something online, but have done it very sparingly.
Maybe once or twice last year, and they have done it because they heard that one gets a good
deal online for a really important purchase, which is usually a mobile phone. They buy one
product, and almost never buy anything else online, certainly not from websites outside the
big horizontal e-commerce players.

Also, these users are extremely price-sensitive. You’ll find it hard to persuade them to pay
even a delivery fee.

Level B : India’s occasional shoppers. At the middle level, comprising roughly 20

million users

These users may buy something online, but will venture outside online shopping very, very
sparingly. Think of users like our moms and dads, who spend money online to get food from
Zomato as a treat, or maybe take an Ola once a month if they are feeling particularly
generous.

College students also form a part of this. It’s a base that’s somewhat comfortable online, but
can’t be relied on to spend regularly.

Level A : India’s California users. At the highest level, comprising 10 million users

If you are reading this, you are likely in this category. You are a digital native. You buy nearly
everything online—from products, to groceries, to food. You may even have a Netflix
subscription. You are the elite user—the one with a lot of spending power, and who is
comfortable buying that lipstick from Nykaa or that cold brew from that fancy direct-to-
consumer startup in Indiranagar, Bangalore. You probably use Dunzo, and maybe even pay
your bills on CRED.

This is the customer everyone desperately wants, especially because India’s California users
punch above their weight. They may be just 15% of the active transacting customer base, but
according to one founder I spoke to, they account for nearly 40% of the money spent by this
pyramid.
Again, there are ways to triangulate this. In its recent pre-IPO report, Zomato, which is a food
delivery service and had a strong use-case during a pandemic, reported an average monthly
transacting user base of...10 million users. Netflix has about 3 million subscribers in India (and
has started tapping out) CRED claims to have about 6 million. Amazon Prime has 6-7 million
users.

10 million users.

That’s the population of Sweden.

And every single Indian consumer internet company is fighting for them.

The reason why everyone is fighting for the same users is because this base of 70 million
users isn’t growing as rapidly as it should. The growth of this pie is tied to one thing, and
that’s the per capita GDP of India. If more Indians make wealth, then more people will fall
into this consumer pyramid. Right now, that does not seem to be happening fast enough.
Here’s a graph of the GDP per capita growth of India. Notice the growth rates below in green
bars. See how they’ve gotten smaller with time.

India’s current per capita GDP is a little over $2,000 right now. There’s a direct link between
the per capita GDP and the number of active transacting customers online. And it’s not linear.
Take China for instance, which has a per capita GDP of around $10,000. That’s five times of
India. Alibaba, their largest online horizontal commerce platform, has an active transacting
customer base of 800 million users.

India has just a tenth of that, assuming the best case scenario.

And this was before the pandemic. We still don’t know the full impact of Covid, but it has
almost certainly set us back by several years, with millions thrown back into poverty. China,
on the other hand, has rushed ahead. Remember, any growth we may have seen in the GDP
per capita has also almost certainly been inequitable— it’s gone to the rich people and less to
the poor. This is likely why we probably haven’t moved much from the 70 million number.

All of this leads to a few implications.

Implication 1 : Horizontal players like Flipkart and Amazon are at the outer limits

Both of them have practically captured most of this pyramid, and are now in the business of
trying to maximise repeat purchases or even a second purchase from a large part of the 70
million of this pyramid, and a first purchase from those outside it.

This does not mean that they won’t grow. They will. But it will be a long, hard, and expensive
grind.

Implication 2 : The rise of vertical-specific players from this 50-70 million pyramid

Any new internet company has to play within this pyramid, and the more successful ones are
creating use-cases for verticals. Food Delivery. Rides. Fashion. Groceries.

The best part is that winning that vertical is good enough. If a company is able to get just 2-3
million users, especially from that top 10 million India-Californian customers, they are golden.
Take Licious, which recently reported that it had delivered to over 2 million users. Poof.
Unicorn.

Take my money, says the VC. You are a market leader in that vertical, so I’m going to back
you.

This is one of the reasons why leaders in individual verticals are getting a surge in funding.
VCs have decided that winning a vertical is good enough for now, and so they are backing the
leaders.

But why? Because...

Implication 3 : It doesn’t take a lot to compete in a vertical and stay competitive

Remember that these 10 million users aren’t value conscious. They are product and service
conscious. If something is a better product, these users switch to it. Everyone was buying
cosmetics and beauty on Myntra and Flipkart until Nykaa came along. Licious took money
away from offline groceries. Pharmeasy took money away from medicine stores.

You don’t need a lot of money to stay competitive if you are a vertical leader. Maybe $200-
300 million a year tops, according to the aforementioned founder I spoke to. It’s a no-brainer
for a VC to fund a vertical leader for that amount and give them a unicorn valuation.

This is why we are seeing a sudden rise in unicorns in India. Salaries go through the roof. All
these companies are competing for the same talent in India. The pie of qualified, smart
developers in India is also not growing.

Implication 4 : However, at a certain point, it gets harder to justify valuations from VCs

From a VC standpoint, returns are expected over a 3-5 year period. And that’s why we’ll see
the rise of many unicorns in India, and maybe even a couple of decacorns, but no more.

There are limits to vertical companies. And that limit is 10 million users. Once a company hits
that number, very few private capital players are willing to fund companies because it’s clear
that the next level of growth is going to take a long, long time.

Much more than 3-5 years, which is a typical VC horizon.

Implication 5 : So some companies go public

At this point, companies just choose to go public. Public markets have more liquidity, and they
have more patience with companies, which need a place to wait it out until the pie grows,
which may take 7-10 years. And if VCs can’t wait that long, maybe the public will.

The question is how many companies can enter into the public market, and at what point does
the valuation stop making sense, even for an excited public market.

That’s the real question.

And that’s why India won’t see a $100 Bn internet company anytime soon.