Conventional wisdom in the venture capital business is that a small percentage of investments generate the majority of returns. The 80/20 principle still resonates in the venture capital ecosystems of the U.S. and other developed markets despite last year’s notable VC investment catastrophes and research showing that VCs pick winners just 2.5 percent of the time. Despite this, the venture industry in the U.S. is seeing unprecedented growth in recent years, with investments upwards of $130Bn annually, and is being emulated around the world including parts of Asia and Africa.
But venture investing in emerging startup ecosystems like Southeast Asia (SEA) is fundamentally different from Silicon Valley.
U.S.-based VCs tend to back a lot of breakthrough innovation and transformational technologies and experiment with new business models. This is an inherently high-risk approach. For every Airbnb there is a pile of Zume Pizza slices in the garbage bin.
In contrast, the early iterations of venture investing in emerging markets tend to focus on companies with technology and ideas already proven in developed markets that need to be adjusted in order to flourish in a developing market with different demographics. Founders and their investors can learn from the successes and failures of the same models in other markets rather than figure it all out on their own.
The challenges that come with backing startups whose business potential is unproven in the new market are still there but the overall risk profile is lower because the starting point is a proven model.
Success depends more on execution and the translation of the business concept to a new market than on picking the right technology. Unlike developed markets where pushing the envelope may seem to be the only way to get ahead, venture capital investors in developing markets have the benefit of hindsight. We have seen this in the success of Grab and Gojek in SEA which started off by emulating Uber but quickly adapted the idea to make it relevant for the SEA consumers. Instead of cars, they focused on scooters as a more accessible, scalable, and easily maneuverable solution for the famously crowded streets of Jakarta. They also enabled customers to transact in cash, critical when you’re serving a large unbanked population that doesn’t have access to credit cards.
A decade ago, 80% of Southeast Asians had limited or no access to the internet, according to the 2019 SEA Internet Economy Report from Google, Temasek and Bain & Company. Now Southeast Asia’s 360 million internet users are the world’s most engaged mobile Internet users; 90% of them connect primarily through their mobile phones, according to the report. Moreover the region is one of the youngest populations in the world creating a huge captive audience for companies like Kredivo.
And we’re seeing similar unprecedented growth led by digital transformation in almost every sector in the region.
Consider the more than 100 million small and medium-sized enterprises (SMEs) in SEA, which represent 99% of all of the region’s business establishments. More than 80% of 370 middle-market firms across the region recently surveyed by EY plan to increase investment in “transformative technologies” over the next three years. Not surprisingly the region’s start-up ecosystem is gearing up to leverage this opportunity.
Early successes include Indonesia’s Warung Pintar, which helps traditional businesses digitize their business and Vietnam’s Kiotvet, a leading cloud-based store management software for SMEs and MSMEs.
It’s true that the biggest barriers to entry in these markets are often related to operating complexity but it’s also true that regions like Southeast Asia are significantly underserved, compared with mature markets. As a result, there are opportunities for more participants to succeed than in developed markets.
For example, one of my firm’s portfolio companies, Kredivo, is going after the consumer lending space in Indonesia where the credit card penetration is about 5%, compared with 70% in the US. A developed market equivalent to Kredivo might be U.S.-based Affirm. So even if more competition shows up in Kredivo’s space, there’s still plenty of room for several mega-companies to be formed.
To be sure, this broader and deeper list of opportunities in developing markets doesn’t make it easier to pick winners. That’s because there’s increased execution risk in these complex operating environments. This means that certain key considerations to identifying and making successful investments are different from developed markets.
For example, investors must closely evaluate whether the developing market gap that an idea seeks to close is the right one to focus on first, if the solution necessarily needs to be a local one and most importantly if it is the right team and timing to solve the problem.
Research suggests that most businesses fail because of leadership challenges and a lack of capital. Given that the talent and capital pools in emerging markets are still developing, it makes sense for venture capital investors to focus more resources on fewer opportunities to increase their chances of success.
To be sure, it’s too early to say if emerging market VCs are defying the 80:20 rule. But given the market gaps and opportunities we see, the time is coming, and soon.