Opinion: India's Regulatory Climate is a Challenge for Startups
India is emerging as a global economic hub. The 1.3 billion population market size has attractive many businesses of all sizes to capture value. India's economy is complex, with a huge demographic range and a complex regulatory system. Each region is different, each state is different and each ethnic group is different, which acts as a huge barrier to entry for new startups in India. The country's regulatory system still acts in a very traditional, volatile and unclear manner.
Startups have limited funding and expertise of the VUCA (volatile-uncertain-complex-ambiguous) regulatory-environment. Swiftly changing and unclear regulations for the innovative spaces which startups these days operate in has discouraged new startups to enter and has even caused many to go out of business. India must offer a clear regulatory climate for entrepreneurs to bring in new and innovative solutions to the traditional economy, especially as many large private sector players aim to make India a digital economy.
India Overview
All eyes are on India as it emerges as one of the world's largest economies. India has a GDP of $2.7 trillion and has seen GDP growth of 5% to 8% in the fiscal years before COVID-19. As a result of Govt. led campaigns such as 'Make in India' and ‘Atmanirbhar Bharat’ (Self-dependent India), many foreign investments have been made into India, as large corporations see it as another manufacturing hub. Companies such as Apple and Foxconn have already invested $1 billion this quarter, making the total foreign direct investment equity influx approx. $470 billion in the last few years. RBI interest rates have been trending downwards from a range of 5% to 7%, which shows that the economy is ready to support the private sector and stimulate the economy. In addition, there is a huge push to transform India into a digital economy, with the likes of Google, Jio and Facebook investing billions of dollars to improve digitization.
Though India's economy is growing very fast and has a massive potential, it still has a way to go. More than 60% of the population still reside in rural areas, depending on agriculture for livelihood, and of those, 25% of the rural labor force remain unemployed. Additionally, most of India, culturally, still follows many traditional ways of conducting commerce, which will be a costly and time-consuming challenge to overcome for innovative companies entering the market. COVID-19 has also caused a major setback for India. They are seeing rapid increase in cases, as India becomes the next hub for this virus, with almost 80,000 reported cases a day. In Q1, the economy has contracted by almost 24%, which is the biggest crash India has seen in the last 40 years. The urban unemployment rate alone has climbed up to 10%, as companies struggle to keep themselves afloat.
Startups in India
Starting in 2016, Narendra Modi's Govt. had initiated the Startup Initiative with the aim to promote entrepreneurship in India. As a result of the initiative, nearly 20,000 startups entered the Indian market, across all sectors. India has seen some unicorns develop in many different sectors including EdTech, Food Delivery and FinTech.
As part of the Startup Initiative, the Govt. created an online platform for startups with various resources. Firstly, they have created a platform which allows startups to interact with the Govt. and regulatory agencies. In addition, the portal also allows for startups to network with other startups in India and get connected with potential investors through incubator and accelerator programs. Furthermore, the online platform also provides startups with educational material so entrepreneurs can better lead their companies.
In addition to the government Startup Initiative, trends in India are also creating giving startups more traction. India has a huge youth population (30% of the population), who are becoming more and more technology dependent. There are top-ranked universities in India such as the Indian Institute of Technology, who's alumni are now at the helm of the largest corporations in the world (Google, Microsoft, etc.). With these top-rated programs, India is also seeing a trend of more students opting to remain in India to pursue their higher education (40% decline in Indian applications to American universities) as they see a strong professional future at home. Furthermore, with information becoming more symmetric, entrepreneurs have been made aware of significant inefficiencies in the market (e.g. 30% of agricultural output is wasted in India), highlighting opportunities for them to tap into.
With strong incentives and trends in favor of startups, why are they struggling? More than 90% of startups in India fail. Obviously, there are many reasons for this; lack of innovation, lack of funding and poor business models being some of them. However, the complex regulatory landscape for startups in India acts as a major challenge for success.
The Regulatory Problem for Startups in India
Smaller startups tend to focus on niches and provide innovative solutions to the consumers in that niche. However, startups in India have struggled to carve out a portion of the Indian market in their respective niches.
Though the Govt. has created a platform for startups to connect with regulatory agencies, the landscape, in general, still remains very traditional when it comes to interacting with such agencies. Startups disrupt traditional businesses, as e-commerce has disrupted the brick-and-mortar retail sector. Brick-and-mortar still has a major presence in India, through companies such as Future Group, Reliance Retail and the 12 million 'Kirana' stores. Therefore, these business owners have fought many startups trying to disrupt this traditional space. For example, in August 2018, the Union Ministry of Health and Welfare asked for a lengthy registration process of e-pharmacies to regulate startups because many pharmacies (26,00 in Bangalore) shut their stores in protest of e-pharmacies. Another great example of this is Ola Cabs. Ola Cabs is India's largest rideshare business, competing with Uber, but did begin as a startup. India's regulatory bodies required for Ola to have their branding on all of their cars, it could not be a private car where anyone can drive as Uber's model is like in western regions. This was to make sure older taxi drivers and meter taxi drivers livelihood was not taken away. It is understandable why the Govt. has to keep regulation tight for startups, in favor of traditional businesses because they employ a large portion of the population economy.
Regulations for startups change very suddenly and can completely disrupt the startups business. As mentioned, startups have limited funds therefore any changes in regulations, especially sudden ones, can have an adverse effect on their business as it can be costly and time consuming for them to adjust (some startups spend up to $20,000 to account for regulatory changes). For example, last year, the Reserve Bank of India reiterated its opposition to cryptocurrencies. Though digital currencies are still a gray area in many nations, countries such as China and Singapore are adapting to it with the aim of launching their own digital currencies by 2021. The decision by the RBI was sudden and was made without consultation from startups in India, highlighting how many startups do not have a clear path ahead. The rule has since been amended in March 2020 to no longer have bans on trading and exchange of cryptocurrencies.
Incorporation and Tax compliance are two major factors affecting the success of startups in India. Incorporating a company in India is a long process, it takes up to 3 months, compared to 2 days in countries such as Singapore. Startups face additional barriers to the lengthy incorporation process, such as rejections of startup names on weak basis and additional re-registration and verification processes. This not only adds time to a startups incorporation, but also huge costs. For example, e-pharmacies have to pay INR 50,000 (approx. $700) for registration, they are not allowed to advertise any medications or drugs and have to re-register and verify themselves after three years. This extensive list of requirements makes it very difficult for cash-strapped startups to grow to their full potential. In terms of tax compliance, the income tax department requires many details from startups, including the name and portfolio of each investor into their business, even if the investors have only put in a small amount. In addition, rules by the tax department for employees to pay taxes upfront to exercise their ESOPs, results in significant cash flow problems for startups.
India's legal process is very lengthy and cheap. As a result of this, many consumers in India are not shy of engaging in legal disputes with startups, or any business for that matter. There is an over supply of solicitors in India, which has allowed for cases to be filed in court for reasons with very little premise. Lawyers in India can cost only a few thousand rupees (<$100), and this gives litigation access to a large portion of the Indian population. This is a hurdle for startups in particular as they are trying to bring in something disruptive, which ultimately may upset the consumer in one way or another. The lengthy process of litigation might be something which consumers may have an appetite for, however, for a business it is a big challenge. It causes financial, repetitional and operational damages.
Lastly, the current legal climate makes it hard for startups to attract and retain consumers. There still remains an essence of 'hustling' and 'bargaining' in some Indian consumers, which startup services are not equipped for. For example, AirBnB users in India may opt to try and reach out to property owners directly, so that the cost of stay goes down (since AirBnB's booking fees will go). Additionally, traditional businesses pose another threat here as they can respond to the consumers' bargaining (land brokers may negotiate a lower commission so consumers will use their service), and therefore can undercut startups in many different ways.
Conclusion
India has the potential to be a hub for innovation and technology and become a place where startups are paving the way forward with their new ideas. However, they face significant barriers from the regulatory landscape. I attended a conference at HBS, wherein global Venture Capital firms expressed their interest in the Indian startup space but were wary of entering because of the regulatory and bureaucratic barriers.
Though the Govt. has sparked an interest in startups with its Startup Initiative, many policy changes need to occur on the ground level for startups to succeed at a higher rate in India. It is understandable that the Govt., at present, cannot make too many large changes in favor of startups because traditional businesses still play a fundamental role in the economy. This raises the question whether India is actually ready for a shift in its economy to a more digitized world. Lack of technology adoption on a business level, complex supply-chains and hard-lobbied regulatory barriers will be a challenge startups will face in India in the near future. Big Data, AI, Cryptocurrencies, etc. are somewhat regulatory gray areas in many nations, yet, many markets, such as the US and China, are adopting to these innovations by making the regulatory landscape for startups friendlier. India must do the same if they want to remain competitive, as solutions startups come up with are the future.
However, I believe, now that the big boys (Facebook, Google, Amazon and Reliance) are all actively trying to transform India into a more innovative/tech/digital hub, it should create a more startup friendly environment in terms of regulation.
My opinion was formed studying reports, financial news and general trends. Please let me know if you have any questions, thoughts or feedback. Thank you.
Written By,
Abhishek Khetan