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Current Issue • Jan-Mar 2017

Failure is a Necessary Part of Innovation

Failure is a Necessary Part of Innovation

Sanjay Subhedar, founding Managing Director of Storm Ventures, and member of the Governing Board, ISB was at the Indian School of Business, and during his conversation with C Chitti Pantulu, former Director – Marketing and Communications, talked about the start-up environment in India, innovation landscape and the e-commerce space.

Chitti Pantulu: Innovation is coming from unseen quarters. And looking at it from where you are, the Valley being the epitome of innovation, do you see India ever getting anywhere close to that?

Sanjay Subhedar: There are two things. One, is that the US will continue to be the innovation hub for core technologies for a long time to come. The reason is that it has three elements that are unique to the US. They have a large defence department, with a big budget, with an ability to fund a lot of things that it is interested in. So if you look at it historically GPS, radar, laser, and DARPANET, which subsequently became the Internet and World Wide Web, were based on that. These technologies came from research that the defence department or DARPA funded for its own purposes. So it is unique that they have a lot of money to spend on fundamental research.

The second thing that we have in the US is probably the 100 best universities in the world which attract the brightest students to the Bachelors, the Masters and the Ph.D. Programmes. To be awarded a Ph.D. degree you have to invent something, you have to be unique. A large Ph.D. population at universities, working diligently to come up with innovation while being funded by the industry and through the defence department, helps the university. This is unique to the US.

The third element that the US has is its middle management in successful companies which can come in and take innovation and commercialise and scale it, make it affordable, make it reliable and so on so forth. You need these three elements for innovation to get out of the lab where you create.

I feel that the core technologies have done such a good job of delivering such high amounts of storage, bandwidth and compute power that now we need applications to harness those core technologies. And in those applications I think India can become an innovator. So it will not be core technologies but applications that will be disruptive to the way things are being done. Three areas that I am hopeful about are healthcare, education and government where technology can, and should, play a bigger role to reduce costs. India can play a role here because it has a good number of people. And you combine that with good quality, because we have very good engineering schools, and now enough good management schools. So that combination, with the English language skills, gives India an advantage in terms of people power.

Talking about this entire start-up environment, currently we seem to be at a very interesting phase, particularly in the ecommerce and mobility space. But it also seems to be undergoing some kind of turbulence at this point of time particularly in India. Valuations seem to be on the down. What is your view on what is in store for this entire space?

It is interesting. I think that there are five or six so called unicorns in India which has never happened before. And two companies that have a very high profile are Snapdeal and Flipkart. They grew very quickly, and clearly the investors put in a lot of money in them that allowed those companies to offer goods at very cheap prices to the consumer. But now they have started running into trouble and that is where I think scaling the enterprise is important. This is what Dean Raj Srivastava and I have been talking about where I would like to see ISB become known for building managers or creating or helping managers scale enterprise.

What has happened is that after the US, the next big open market for any technology company is India. So what happens is that companies, like Amazon and Uber, companies will want to succeed in India and they will pour in a lot of money in to the country. And Amazon knows how to scale, they know how to do their logistics, they know how to do customer outreach and they know how to keep customers happy. So all of those things are something that we (Indian startups) are going to find an uphill task if they don’t learn fast. Otherwise they may not be able to sustain the valuations. They have already come down.

We have in the US probably the 100 best universities in the world which attract the brightest students to the Bachelors, Masters and the Ph.D. Programmes. To be awarded a Ph.D. you have to invent something, you have to be unique.

There is one other thing that I would like to know from an investor’s perspective. An interesting feature that one is seeing is the total breakdown of geography. What the Uber deal has actually shown is that the repercussions of amending one geography have an impact on another geography. And then, the other aspect is that business models don’t per se seem to be unique to geographies any more. Be it a Lyft in the US or an Ola in India, they are facing the same problems because of M&A activity that is going on elsewhere. So what has changed fundamentally?

I think there is this thing called network effect which is very powerful. What happens is that when you are competing as a network, the bigger network will always succeed. And so you need to get big fast. Let us take an example. There are a lot of applications for you and me to video chat or even chat. But WhatsApp has become so large. It has got about one billionusers. Now if you are on WhatsApp, and many of your friends are on WhatsApp, they are not going to sign up to a new network because it is easy for them to communicate on WhatsApp. So WhatsApp becomes the dominating network. In any other technology there was always room for multiple players. But when you have an application or a business model that depends on the network, and being part of the network, is very valuable for each individual in that network, then being part of a network that is the largest becomes the most important thing. Uber is one of those companies which is really a software company with no cars. So once I am on Uber and if I am traveling like a business traveler, like I do, and if I can use Uber in Delhi, Mumbai and in Bangalore, and in New York, that is what I am going to use. I don’t want to use DIDI in China or Ola in India because I don’t have those apps. And if Uber has my credit card and my information and my preferences, then it is easy for me to use that application anywhere I go. So Uber has an advantage just like WhatsApp. So the importance of networks is very important.

One of the criticisms about the Indian ecommerce space was that perhaps it was hyper funded – particularly the Flipkarts and the Snapdeals, when they started off. If you have to be the biggest player in the network, you have got to have big pockets and you have to invest a lot of money. But at the same time the big money that has been invested in these companies has become the problem. Valuations have shot up and maybe now they are down, which people say is perhaps a realistic level. Where is it now?

I think historically if you look at any technology it gets over-funded and that is absolutely true if you look at the Internet routers industry. Cisco is now the dominant player in routers but there was a time in the mid ‘80s to mid ‘90s, for ten years, at least 200 router companies were funded by investors, including the VCs, because everybody thought that their company would be successful. And everybody is trying to be No.1 or No.2 or No.3. And in that business there were at least 10-30 companies that went public. So they had good exits and good returns for their investors. So what is happening is that markets are getting global. You could have leaders in particular geographies and particular niches. But today in approximately 130 to 170 countries there is some uniformity across in technologies. And so, like you said earlier, the world has become flat and you have to compete at that level. For this you need a lot of capital. And everybody dreams that their company is going to be No. 1. And they all strive and they all run. But there will be only one No. 1 and unfortunately it is not just capital that is needed, but also good the execution. If you don’t have it you can’t succeed.

I think there is this thing called network effect and this network effect is very powerful. What happens is when you are competing as a network, the bigger network will always succeed. And so you need to get big fast.

How does India look given the kind of specifications that you have? Do you see enough start-ups thinking global and do they have the technologies and the application mindset that you mentioned?

15 years ago our LPs used to say why don’t you invest in India? I am talking about late ‘90s and early 2000s. Start-ups in India were doing business process outsourcing. Call centres were a hot area followed by back office accounting, back offices for legal services. It was basically labour arbitrage and there was no technology per se. As an early stage investor it was hard to figure out which of these outsourcers was going to execute well and scale up and be successful because there was no technology that we were investing in. We just stayed away as we can’t add value sitting 10,000 miles away if it is mere execution. The next phase of start-ups in India was the domestic copies of successful business models in the US like Shaadi.com,  Naukri.com, Monster.com or MakeMyTrip. Again they were addressing domestic markets and we just stayed away from that too. But this third phase I think is going to be enterprise businesses that will be started to solve problems for enterprises that will have global aspirations. And I expect that over the next five or ten years we are going to see companies started in India that will also be global technology players. So I am hopeful and am looking at deals and meeting entrepreneurs and trying to see if we can make investments.

Recently you announced a $10 million SaaS fund exclusively for India. How do you see the prospects? And a related question is that you already have the biggies with deep pockets playing in this space. Even smaller companies are going to them to get their business. So don’t you think it is a difficult scenario to be in?

Yes it is always challenging. It has always been. We only invest in companies that are addressing big markets because if the market is big then there is an opportunity for our portfolio company to become a big player. But by definition if it is a big market already that means there are successful companies already selling in that market. Otherwise it wouldn’t be a big market. So we always invest in young companies that are competing with the very successful older companies. And what we are trying to do with new technologies and new business models is to disrupt the entrenched player and the entrenched leader and get market share away from them. So we are not afraid of competing against a Google or Intel or whoever that might be.

We always invest in young companies that are competing with the very successful older companies. What we are trying to do with new technologies and new business models is to disrupt the entrenched player and the entrenched leader and get market share away from them.

That brings me back to the first question about innovation. Do you see enough innovation happening and do you see Indian start-ups disrupting bigger companies? Will we be able to see a Google or Microsoft coming out of India, maybe in the next ten or 15 years?

I am not sure because Microsoft had businesses  applications like Word, PowerPoint and Excel and Google was into search essentially. But I can see something like an Uber or Airbnb coming out of India. Because Uber is not a technology, it is an application that connects people and does a very good job with a very good UI. And so in that class of business model innovation I see a lot of opportunity for Indian entrepreneurs to come in and do something.

One feature unique to India is that perhaps we don’t seem to take too kindly to failure. And people say that perhaps that has been one of the reasons why we haven’t seen many attempts coming out of India. Do you see that changing somewhere and how good is failure?

I think failure is very important in our business and we have to accept it, and we do. If you say failure is where you don’t get your money back I would say 50% of our investments turned out to be failures. But there is always a learning from that. So failing is a necessary part of any innovation, any progress, and we have to accept it and embrace it. In most societies, in most cultures, fear of failure is a human nature. But the environment has changed so much now and people accept that. My father worked for the same employer all his life. And I have worked for maybe eight or ten companies in my career. I think the next generation of young people will probably be working for 30 or 40 companies. And so, the pace of change is accelerating and change means challenges and failures. But I will tell you that a 3rd of our companies do some development in India either in Bangalore, Pune or Hyderabad. And every time I visit I go and talk to engineers in my portfolio companies’ back office teams, and these are bright people, I ask them the challenges they face for working in an entrepreneurial company that is based in Silicon Valley but has offices here in India. A common struggle is that portfolio companies are no-name companies and that is a big challenge in the marriage market. They are not Microsoft, Google or Facebook. So there still is a part of society that does not look too kindly if you work in an unknown start-up.  But there are a lot of people graduating from engineering schools here who are starting companies. They are bright, they are passionate and not afraid of failure to the extent that when some of them succeed, the parents and other people say it is worth giving a shot.

The undergraduate educational system in India is excellent and will continue to be so for some time. The IIMs and ISB are certainly great schools. When we started 15 years ago the vision was to be in the top 100 and we have clearly achieved that vision and are trying to get in the top 10 or 20.

To wrap up, you mentioned the network of universities. How do you see India and institutions like ISB shaping up in this respect? Do you think they are changing the game? Do they have to do something more than what they are doing?

I think India has some of the best undergrad universities. And when I look at where we are funding in the US, I would say that a third of our companies are started by Indians, meaning somebody who went to school here, did their undergrad here, came to the US for their Masters and worked there and wanted to start a company. So the undergraduate educational system in India is excellent and will continue to be for some time. And now the graduate systems; the IIMs and ISB, are certainly great schools. When we started 15 years ago the vision was to be in the top 100 and we have clearly achieved that vision and trying to get in the top 10 or 20. So ISB is very valuable because to scale these businesses, to extract the maximum value, you have to build big businesses that can work across multiple geographies, multiple countries and across very complex regulatory and government environments. And for that you need good middle and senior management. I am encouraged and hopeful that ISB is going to train some of these people who will be tomorrow’s leaders in these companies that scale up.

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