Causes of the downturn in the startup ecosystem: A few propositions

Ravishankar V. Kommu Assistant Professor, IIM Amritsar

Startups in India are laying off staff in big numbers

The pink press is abuzz with hypotheses that may have brought this situation about The popular blame is on the ‘funding winter’ thanks to the economic volatility around the world due to the pandemic Not enough emphasis is being placed on the fact that in a moment of crisis, investors want to withdraw immediately from the ecosystem, signaling their lack of faith and the low priority they assign to investments in technology and innovation

Disappointing results by some of the tech giants such as Meta who chose to invest in innovation has also contributed to the change in market sentiment

Nevertheless, this gloomy period is the right time for us shed some light on some of the structural issues in the startup space in India there is debate on what a startup exactly is, and any attempt to properly define it could leave out crucial aspects, and therefore it is important that we depend on a popular understanding of what we understand by the term ‘startup’ (Cockayne, 2019) The term denotes the age of the firm, but more importantly it also suggests commitment to technology and innovation

However, as far as technology and innovation are concerned, the proliferation of large incubators that essentially rent out space (and amenities) to entrepreneurs who are developing marginal solutions to problems leads one to suspect that large firms are offloading the risk of innovation onto young entrepreneurs who are investing precious years of their lives to solve problems that many large organizations should have been funding in house

What this means is that a large percentage of these startups are bound to fail by design, and only those that demonstrate a modicum of success are absorbed by large players

Only a very tiny fraction of such startups is ever even supposed to make it truly big, as they are expected to have found an untapped niche Like the scenario depicted in the Harris-Todaro model of urban unemployment (Harris and Todaro, 1970) where only a few migrants from rural to urban areas get absorbed in the industry and the rest remain unemployed and are forced to live in slums, many startups that should have never existed linger around for a long time before eventually meeting their end

Several startups are victims of investor hedging. Investors who want to avoid missing out on emerging technologies invest in a large cohort of competing firms, thereby rewarding the space rather than any specific innovation the startup may have arrived at

For instance, several EdTech firms landed vast sums of money simply because investors were competing against each other and didn’t want to lose out on a potential high growth industry This is due to venture capitalists trying to fish for big game startups using wider and different kinds of nets In a typical market for lemons scenario, founders focus a lot more on making the right sounds rather than on building legitimate organizations, resulting in their firms staying in the fray for much longer than they should

A consequence of ‘technology and innovation’ being the core brand of startups in general is that the ecosystem attracts engineers and innovators who are trying to solve technological problems or come up with smarter solutions This demographic typically lacks an understanding or appreciation for fundamental principles of business management and often only learn them on the job if they happen to stay in the game for long enough Many often lack the customer centricity or understand basic issues in talent management to the extent of even having contempt for marketing or HR divisions For instance, several startups are unable to put together the right teams or can make their teams do productive work (de Mol, 2019) Another consequence of this tendency to anchor themselves in technology is their inability to follow basic unit economics

Many startups are guilty of resorting to solutionism in the name of innovation

For instance, there is no need or demand for groceries to be delivered in under ten minutes and yet, there are several players trying to achieve the same A tragic externality of this phenomenon is large pools of engineering talent who could have been productively deployed elsewhere are choosing to work on things like quick delivery or ‘EdTech’ (where there really is not much tech) Along with signaling an innovation focus, startups are also over hiring talent to signal possibility of high growth or delivery of more complex products

To conclude, I would argue that a lot of what the startup ecosystem is suffering from is a result of

Poor due diligence by VCs has been the bane of the startup ecosystem for a long time now, and a lot has already been said on the matter hubris in believing that they are doing something a lot bigger than they are attempting to posture to investors rather than build a meaningful product and from and, a tendency to focus on ‘problem solving’ rather than building viable businesses