Dragon vs elephant: The elephant may grow slower than the dragon, but that does not mean that it is unsatisfactory

Though there are several similarities between India and China, India will evolve in its own unique manner.

Jerry Li

Amit Sharma

Dragon vs elephant: The elephant may grow slower than the dragon, but that does not mean that it is unsatisfactory

Wednesday September 11, 2019,

13 min Read

“Last two decades were China’s, the next two should be India’s: Arvind Panagariya” – this type of news headline seems quite common these days.

Almost without exception, the major international economic agencies and think-tanks believe India will be the fastest growing economy in the foreseeable future. It is hard to argue with this conclusion; more so, given some moderation in Chinese growth. The Indian economy is pegged at an annual GDP growth rate of at least 7 percent (on a sustainable basis, notwithstanding the recent weakness).


Today, most startup pitches almost inevitably feature a default chart comparing Indian GDP growth forecast to China. All the macro indicators point to the possibility of this growth - young population, a decisive political mandate for bold economic reforms, foreign capital inflows, a growing entrepreneurial spirit, and most importantly the new-found insatiable hunger among the new generation to change the world using technology.

But what does all this mean for the Indian startup eco-system? A large number of startups count on growth in disposable income to convert their user base (DAU/MAUs) into revenue numbers. Even for advertising, the CPM rates are ultimately a function of how much business the new, expensively acquired user can drive. This is where we need to be watchful.

Though there are several similarities between India and China, India will evolve in its own unique manner. China registered much higher economic growth over the last two decades than India is anticipated to achieve. Also, there are certain macro and historical roadblocks for Indian GDP growth to translate into per capita disposable income as it did in China.

The translation in India might be slower than anticipated, which might disappoint investors’ return expectations in the near-to-medium term. However, we do believe it is a matter of when and not if regarding the companies meeting investor expectations.

Per capita GDP growth differential

China has registered much higher GDP growth over the last two decades than India. Moreover, due to low population growth, the superiority of China’s GDP growth to per capita income is even more pronounced.

graph 1

Chart 1: Nominal per capita GDP in India and China over the years

China registered 13.7% annual growth, in nominal terms, from 1998 to 2018, which translated into a 13 percent annual per capita income growth over this period, thanks to just 0.6 percent population growth. In the same period, India registered 9.7 percent annual growth in nominal terms, but per capita income growth has been just above 8 percent due to high population growth.

Though the difference numbers (between GDP and per capita income growth) might look small, but this is where compounding over a long period of time comes into picture. Thanks to the compounding effect, Chinese per capita income, which was less than double of Indian per capita income in 1998, grew to about 4.5x of Indian per capita income in 2018. As visible in the chart above, the increase in Chinese per capita income has been quite steep.

Even from a PPP perspective, which arguably is a more relevant indicator, the story is not much different. India undoubtedly has shown and will continue to show healthy per capita income growth, but it might not be able to match the Chinese trajectory.

As per IMF data-book, China took six years to grow its per capita income from 5,000 to 10,000 units. However, India will likely take nine years to do the same despite marking the highest GDP growth (among large economies) in seven of these nine years.

Graph 2

Chart 2: Per capita GDP for India and China in Purchasing Power Parity (PPP) terms.

IMF forecasts that Indian population will grow 1.5 percent annually over the next six years, while China will grow just 0.2 percent in population every year despite the move away from ‘one-child policy’. Hence, Indian per capita income growth over the next six years is estimated to be about 8.4 percent in nominal terms, moving up from 8 percent over the last 20 years.

Consolidation of wealth effect

Due to the one-child policy coupled with female employment, China has witnessed consolidation of wealth at a household level over the last several years. In China, the one-child policy was implemented in 1979, after which the wealth got consolidated from one, and sometimes even from two generations. The impact of consolidation gets magnified by employment of both male and female in the family. The charts below encapsulate the broad viewpoint.

graph 3

Chart 3: Consolidation of wealth in China from previous generations to this generation

As depicted above, the wealth got consolidated in the hands of current generation from their parents and in some (fewer) instances from their grandparents also. This likely provided financial stability and ability to make discretionary spend for the Chinese young generation. One might argue that Chinese young generation has more people to take care of due to old age; but the annuity spend on old generation should likely be much lower than the wealth accumulated by them (and ongoing annual income generated by that) over the last several years of high-growth phase.

Graph 4

Chart 4: Division of wealth in India

On the other hand, the wealth continues to get divided in India due to multiple children. Though the law suggests otherwise, but the wealth is mostly inherited by male children. Our observation is that most families have multiple male children among whom the wealth gets divided. Also, more often, both the parents are not accumulating wealth or are earning members.

A large percentage of females (some of them despite being educated) are homemakers due to existing social framework in sub-urban and rural areas. It is not to say that a homemaker doesn’t create value; however, the opportunity cost of that value creation might be materially higher (or the replacement cost of her effort might be materially lower); hence, it is not optimal utilisation of female population’s capabilities as in China.

Graph 5

Chart 5: A much large proportion of females are employed in China compared to India despite younger population in India

Absolute income level key for take-off

We discussed above how wealth gets fragmented down to future generations in India in contrast to China. This has resulted in more wealth in the hands of the current generation in China vs India – providing freedom to spend. Another equally important factor is the absolute income level. Assuming that the critical threshold level of per capita income (in PPP terms) of 10,000 units is needed for discretionary spends to take off.

China’s per capita income (in PPP terms) is close to 18,000 units, whereas India lags far behind at around 8,000 units. Even as India is projected to grow ahead of China, it will take India 4-5 years more for its per capita (absolute) income to touch China’s level six to seven years back. India appears to be a long time away. Thus, for both income and wealth reasons, India is at a significant discount to where China is or for that matter where China was seven to eight years back.

How this plays out for higher-order discretionary spends? It might be appropriate to explain this through the prism of Maslow’s need hierarchy.

In China, due to consolidation of wealth and inheritance, the need for safety, which causes lower consumption or less efficient/remunerative savings, got skipped. Due to strong per capita income growth, the physiological needs were quite easily taken care of, while Safety needs were not so relevant due to consolidation of wealth. Love/Belonging is a non-monetary need. Hence, the spend shifted directly to Esteem needs, which drives discretionary/aspirational spend.

It might not play out in a similar manner for India. Though the income and wealth levels have increased materially, we have not witnessed the consolidation of wealth, and thus, we are unlikely to skip the safety needs. A sizeable proportion of the population is moving above the so-called physiological needs, but it might take materially longer time for them to start making discretionary or aspirational spend. They will likely be hesitant to spend money on aspirational consumption items before they have some fixed deposits or real-estate or any other asset providing comfort that they won’t slip back to needing to fulfill physiological needs again.

It is important to highlight that the above analysis is relevant for consumer-internet verticals dependent upon discretionary spending only. The businesses, which caters to the lower-level needs, i.e. physiological needs (as per Maslow’s hierarchy), should be relatively immune to the slower growth of discretionary income. The destiny of such businesses should be less influenced by discretionary spend and more dependent on internal and business-model specific factors.

Chart 6: Maslow’s hierarchy of needs

Source: https://www.coachilla.co/blog/the-new-hierarchy-of-needs

One possible indicator of the ability to spend on aspirational items is the market share of Apple iPhones. In India, this market share hovers between 1-2 percent, while it touched close to 13-14 percent in China in 2015 (it moderated recently due to Huawei issue).

Even in 2010, the first year after Apple started selling iPhone in China, it’s market share was more than 5 percent. More than the numbers, it is palpable that the Chinese consumer is more open to make aspirational purchases compared to Indian consumers. The sales of luxury brands in India is a fraction of the spend in China. These indicators are partially a function of above analysis.

What is this all about?

To be clear, we are not pessimists, but realists. India is among the most attractive global markets and will continue to be so in the foreseeable future, thanks to its population size, potential scale, young work force, low data prices (thanks to Jio), entrepreneurial spirit and several other factors.

Unless something unexpected happens, we can comfortably assume that the next two decades will belong to India. Our above analysis, in no way, intends to counter this view point. However, two decades is a long time for the startup ecosystem.

The limited point here is that India is likely to evolve slower than what some investors, who believe India will go the China way, currently believe. This shall be particularly relevant for verticals and businesses that are disproportionately dependent on discretionary spending from masses. In addition, we believe investors need to adjust their expectations for the fact that India is a much more heterogeneous market with multiple languages, cultures, preferences and context; but similar importance need to be given to the factors mentioned above.

We strongly believe that ultimately the market will exhibit the growth that the Chinese startup ecosystem delivered. However, it might take five to seven years instead of three to five years. Given the importance of time in VC investments, the expectations need to be pragmatic and well grounded. An investor expecting a specific return in three years might not be too happy to get similar returns in five years, driving negative sentiment about an otherwise well-managed company.

The misplaced expectations might drive heating up of valuations causing disconnect between valuations and economic potential. We are incrementally hearing the phrase ‘valuation trap’ for India while talking to some of the relatively conservative/ pragmatic Chinese investors, which might be a manifestation of economics of their investee companies not moving north at the pace they initially believed.

Graph 7

Chart 7: A depiction of potential actual and expected revenue trajectory of investee companies

More importantly, two years can be a really long time in the life of a startup, and misplaced expectations can cause drying of VC capital for a company (and sometimes even a vertical), which really had the potential and just needed more time.

The rush to make it and/or outspend others can also cause unreasonable burn by founders assuming the market is ready, while the more advisable course of action could have been to create the market and put in place a solid execution engine for longer-term, sustainable growth. Such miscalculations can be fatal in certain cases for a business. Hence, the investors in verticals and businesses dependent upon discretionary spend need to be incrementally patient with performance of their portfolio and realistic about valuations.

The above logic might not be as appropriate for certain target markets or some verticals in the country. For example, the businesses focused on rich population and balancing growth versus profitability trade-off might be exceptions.

The chart above provides the distribution of wealth in India as outlined by Credit Suisse Global Wealth Report, 2017. The richest 10 percent of Indians own more than 3/4th of total national wealth. There are about 4 million adults who have wealth more than $100,000 and this number is increasing relatively fast. These consumers are keen to spend on discretionary and aspirational products and services.

A business focused on the rich is unlikely to encounter the issues we mentioned above. One such player in the market is Cred. The fintech platform focused on people with credit cards and minimum credit score of 750 is definitely a product for the higher-end Indian population and has aspirational value. Credit card penetration in India is less than 5 percent currently, and Cred has incremental filters for credit score, and hence, its target market is just about top 1-2 percent of Indians.

Though there is significant focus on taking financial services to the masses, Cred believes that even the elite are not receiving quality services currently. Hence, it targets to resolves this problem and early results are quite heartening. Understandably, it is getting significant interest from investors as well.

The second business we invested earlier this year is Box8. The cloud kitchen has more than 110 outlets in four cities – Mumbai, Bengaluru, Pune, and Gurugram. It operates two food brands - Box8 and Mojo Pizza. The company currently delivers almost 20,000 orders every day. Box8 owns the entire value chain - from acquisition of raw materials to delivery of food. We agree it is a relatively crowded space currently, and some of the adjacent players, primarily on delivery side, have raised large amount of capital.

However, Box8’s founders’ focus on execution is unwavering. The company has seen one cycle of VC capital drying up already, which probably contributed to the strong focus on execution and visible discipline.

A number of players in this vertical are burning large amounts of capital even at EBITDA level to drive growth, while Box8 operates close to break-even at net level. The company operates at high gross margins and tight efficiency. The company’s ability to run operations profitably in the period of heightened competition and still maintaining decent growth rate makes it a strong candidate for long-term win in the market.

Also, it reduces their dependence on VC capital for survival. Not only the founders’ pragmatic focus on economics and efficient usage of capital is impressive, but also their willingness to ensure strong quality and focus on issues at the outlet level differentiate them from the others in the fray.

In summary, we believe that the potential of Indian startup ecosystem is great, but it will find its own pace and trajectory. It will be unfair to expect this to evolve at the pace China was able to grow due to multiple macro, sociological, and historical reasons. The investors need to set their expectations pragmatically, while founders will find it in their interest to ensure that the valuations don’t go out of sync with the near-to-medium term economics.

The higher valuations might seem attractive in the short-term, but in the longer-term, this can be a problem and even fatal. The long-term exit expectation continues to be an IPO for a number of businesses. And one thing we have learned from the IPOs so far globally is the public markets are not as forgiving as the private markets. Private markets might overlook the red bottom-line, but public markets will surely ask uncomfortable questions.

(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)

(Edited by Megha Reddy)