India and the Internet

Its 2018 and its fair to say that by all accounts the internet is a revolution. The fact that half the people in the world can reach each other in a fraction of a second is unprecedented in human history. The only other revolutions that are comparable to this level of transformation in human history are: Agriculture and the Industrial Revolution. Agriculture was invented ~10,000 years ago and the predictability of food production allowed humans to transition from hunter-gatherers to building massive civilized settlements of Greece and Rome. Industrial revolution took place during the late 18th and early 19th century. The new manufacturing methods for the production of textiles, food, iron etc. changed human employment, consumption patterns and societal organization forever. The sustained economic growth, population growth and the increase in the standard of living of the general population witnessed during the Industrial Revolution had never been seen in the 200,000 year history of the human race. The internet is a revolution of similar proportions whose effects we are just beginning to see. As Jeff Bezos, the CEO of Amazon likes to say, we are still in Day 1 of the internet.

One way to look at internet is to compare it to other forms of media, say print or radio or television. The main difference compared to print, radio or television is that the internet is a two way street whereas print, radio, television are primarily broadcast mediums where one side talks and the other side listens. The potential for a conversation in these mediums is limited. The other medium that comes to mind for two-way communication is obviously the telephone. The main difference between internet and telephone is that the internet doesn’t restrict itself to just sound waves, it allows “data-based conversations” and the data can be anything — audio, video, text etc. The other useful thing to recognize is that the internet isn’t restricted to conversations between two human beings, it allows human-to-machine and machine-to-machine conversations. A human-to-machine conversation is you ordering a trinket on Amazon, and an example of a machine-to-machine conversation is Netflix auto-charging your credit card every month.

The richness of the conversations that the internet enables leads to an obvious use-case: trade and commerce. Humans have traded with each other in one form or the other since pre-historic times. The 50,000 feet view of commerce starts with acquisition of raw materials for production, production and the distribution of produced good/service to the consumer. The different entities involved in this chain add value in their own way and take variously sized cuts of the eventual price borne by the consumer. While one can argue about the the importance of different entities in this chain, the final distributor in the chain is evidently valuable since that entity is best positioned to understand consumer demand, purchasing power and emerging trends. Its not uncommon for the final distributor to capture > 30–40% of the value of selling price.

Until internet based trade and commerce became widespread, the final distributor needed to make physical contact with the consumer since the consumer needed to be able to discover the product and for the exchange of good/service for currency needed to happen. Internet, given its ability for high fidelity data-based conversations allows for the existence of virtual distributors, which do not have to have a physical presence near the consumer. The final distributor (and any intermediate distributors for that matter) can be anywhere in the country or anywhere in the world. While a pre-internet distributor would have had to invest in building out storefronts, hiring salespeople and in general having “feet on the ground”, the virtual distributor doesn’t need to do that. This has a significant impact on the economy around the consumer. The pre-internet distributor’s efforts to get to the consumer would invariably create jobs and economic activity around the consumer. This came in the form of businesses that spawned to support the people involved in building and servicing the storefronts. Thus the distribution was a wave that was lifting a lot of boats around the consumer. The internet based virtual distributor has none of these characteristics. It services the consumer in the best way possible, but creates almost none of the economic activity around the consumer. So while the pre-internet distributor had higher costs, a lot of those costs went into supporting the local economy around the consumer. The virtual distributor cuts out the costs and also cuts out the growth of the local economy. But there is one set of people who do benefit from the growth of the virtual distributor and thats the employees and investors of the virtual distributor. The location of these employees/shareholders decides which local economies get enriched with discretionary spend of these people and more importantly with venture capital investment from these employees/shareholders. This especially becomes a problem if the virtual distributor and its employees/shareholders exists outside the country of the consumer. We will return to this point

This is where we come to India. India now has 460 million internet users. Thats more than the total population of USA, UK and Germany combined! With a relatively stable democracy, growth rate of above 5% , it doesn’t take much to realize that India is a valuable market. A valuable market on it’s own is interesting, but it becomes doubly interesting if its going through a massive transformation. India is going through such a massive transformation right now with its population coming online. This is creating opportunities for a new set of entrants to capture the trade that’s moving online. The problem in India’s case is that most of the value of this move to the internet is being captured by foreign companies. India’s major virtual distributors are predominantly foreign. India’s dominant search engine is Google, India’s dominant social network is Facebook, India’s dominant messaging platform is WhatsApp (which is owned by Facebook), India’s dominant online retailers are Amazon and Walmart (with the acquisition of Flipkart). All these companies are American. The problem that this creates is that most of the value of India’s digital life gets captured in the revenue and stock prices of these foreign entities. The major benefactors of that value are the employees and shareholder of these companies, which again are foreign. Thus for every dollar an Indian spends on Amazon or Flipkart, it mostly goes to enriching someone in US. Those enriched people spend most of their money in their communities, in their country, not in India. They buy their groceries at their local stores, they eat food at their local restaurants, they watch movies at their local theaters. More importantly they invest in new startups in their country. Thus every dollar spent by an Indian contributes more to the next wave of startups in the US. This creates a vicious circle. Indian consumer dollars enrich and get invested in new startups in the US which because of getting significant investment are able to make better products/services that they can sell back to the Indian consumer. This is not how the famed tech sector in the US was created. As Americans moved online, the Amazons, Google and Facebooks got bigger and generated huge profits. As a result of these profits, the early employees and shareholders of these companies got huge windfalls, which they invested back in the US tech sector by becoming Venture Capitalists (VCs). Thus the rising tide of the Internet in the US lifted the boats in the US. In contrast the Indian tide is not lifting Indian boats. Its important to note that even within US, this displacement of profits does happen. The money spent online by someone in rural Texas goes towards enriching someone in Seattle or San Francisco. This is where it becomes important to realize why domestic profit displacement is different from International profit displacement. Domestic profit displacement, while still detrimental, is not as bad because within a domestic setting labor is mobile. So John Doe in rural Texas can move to Seattle or San Francisco relatively easily and participate in the economic activity generated by their online spend. This is not true for International profit displacement. Someone from Saharanpur or Bhopal can’t move to Seattle or San Francisco by just getting in their car and driving for a few days. Thus in International profit displacement, the profit and capital moves, but labor can’t. This immobility of labor creates a long term problem for India, where the tide of the Internet transformation will not lift vast swathes of India out of their present financial depressed circumstances.

India only needs to open its Himalayan window look a little north for a different model. China has about 700 million internet users. They talk to each other on WeChat, buy things on Alibaba, search on Baidu. All those companies are Chinese. Their combined net worth of these 3 companies is ~$1 Trillion, most of which gets captured by China resident employees/investors who can create a virtuous circle in China. China has achieved this by making it onerous for foreign entities to compete in China. While that might hurt a country if it’s a bad market and is desperately trying to attract investment, India is not a bad market. India is the only country other than China with a GDP larger than 1Trillion and a growth rate of over 5%. This is a drool worthy market for any investor/company looking for growth. The Indian government needs to recognize that it’s giving away the keys to the castle to large foreign entities who are going to create most of their value in their home country. The Indian consumer and the Indian economy is the innocent host plant which is going to be sucked dry by these entities if the government does not intervene. This sounds protectionist, but favoring the growth of local companies is more beneficial to the Indian citizen in the long run, even if it means losing access to some beloved product in the short run.

India has seen the exploitation movie play out before. Indian raw materials formed part of the fuel of Industrial Revolution in colonial Britain. Selling industrial manufactured goods back to the Indian market sucked capital from India and kept fueling the rapid Industrialization in Britain. India ended up destitute and under-industrialized, holding back the progress of its people for over a century. There is a window of opportunity for India to prevent a re-run of that horror-show, but it needs to act now and act decisively.