Internet: Is This Really a Hot Space Date:   Monday , June 29, 2009 In the past three years, there has been significant venture capital interest in Indian Internet companies. According to research firm Venture Intelligence, VCs have invested US $472 million in 62 Internet companies since 2006. As per the Internet and Mobile Association of India, there were 30 million active Internet users in the country in 2006. In light of worldwide trends, most analysts were predicting this number to grow very fast and hit 70-80 million by 2010. Current estimates, however, suggest a much more modest growth to 42 million users. The reasons for this are well-known: high cost of PC ownership, government policies prohibiting unbundling of last-mile broadband connectivity, and the relative absence of content and services relevant to the mass market. Hence it appears entrepreneurs will have to innovate within the constraints of a small user base to create great companies rather than rely on explosive growth. Online Utility Services This decade has been characterized by the emergence of the holy trinity of internet services in India – travel, jobs and matrimony. These three sectors have a few things in common: they are all essential “utility” services rather than discretionary entertainment services; in each case an existing offline process has been migrated online and thus made more efficient; and there have been people willing to pay for each service – end users in the case of travel and matrimony, and recruitment agents in the case of jobs. The challenge for the industry now is to find other such utility services which can be made more efficient online. And segments like real estate, education and personal finance show promise, but it may take time for the right business models to emerge. Advertising and E-commerce Unlike in western markets, there are few large internet companies in India whose primary business model is online advertising. This is because the annual monetization rate from advertising in India is approximately $1per unique user – barely enough to cover the costs of user acquisition, retention and content. Also, this means a startup will take at least 4-5 years and a very high market share to achieve sufficient scale and profitability. Indian advertisers are still looking for reach rather than niche segments online, so a bulk of the $200 million annual ad spend goes to the top 20 websites – including Google, Yahoo, Rediff and Indiatimes—leaving very little for small players. Overall, we are not confident that websites relying solely on advertising revenues can achieve the desired scale and profitability. Exceptions to this may include high-engagement services that people access several times a day, which may break the $1 per user barrier. According to IAMAI, the online retail business in India was only $175 million in gross revenues, representing approximately $25million in commissions/margins. The initial reasons we ascribed to this were simplistic: problems in logistics, reliability and payment methods meant that only soft goods e-commerce (travel, classifieds etc.) could work in the country. Over the past two years though, our views have become more nuanced. The fundamental issue is not one of soft v/s hard goods, but that of commission margin v/s costs. Certain soft-good segments like travel still face a margin crunch because commissions of 3 to 5 percent are not always enough to cover the high cost of customer acquisition and telephone support. On the other hand, certain hard-good segments like customized gifts earn very high gross margins of 30-35 percent, enough to cover the high costs of logistics and cash payments. So entrepreneurs in e-commerce will do well to find models where they can earn commissions of 20 percent or more, making such companies venture fundable. Mass-market Services Well, the two vehicles most often cited for this are assisted internet services and local language services. Assisted services – typically service kiosks where a vendor uses the internet to provide services like ticket booking, e-commerce or matrimonial matchmaking – cleverly circumvent the problems of payment methods, computer literacy and PC ownership cost. Some companies, notably in the e-commerce and matrimony segments, have taken the initiative to set up hundreds of internet kiosks by partnering with local entrepreneurs. The success of such initiatives, however, will depend on the economics of the business – currently the kiosk owner reportedly makes 3-5 percent commission and the service provider barely 1percent. Whether these services will scale quickly enough to cover the cost of setting up and supporting such kiosks still remains to be seen. Local language services have worked well in almost all non-English speaking markets, notably in China and Europe. India is a unique market consisting of largely English-speaking computer users, and a much larger base of computer non-users who don’t speak English. However, the first set of services for this market – the essential services cited above—will be language agnostic where local language sites will not have a huge differentiator. Mass-market users are far more likely to have their first Internet experience on mobile phones, where local language content will be more relevant. The author is Vice President IDG Ventures India