Mar 18, 2015

Indonesia start-ups: Growth inflection

Indonesia has relatively incubators, angels and entrepreneurs with businesses of investible quality. Does the recent large investment in Tokopedia suggest the start-up ecosystem is now coming of age?

The emergence of Indonesian online marketplace Tokopedia is not only remarkable because of the relatively humble backgrounds of its founders - neither was educated overseas - but also because the landscape into which it launched. CEO William Tanuwijaya spent two years trying to raise capital before making a breakthrough in 2009. There were no incubators, few mentors, and even fewer local internet success stories to speak of.

At the same time the e-commerce space was filling up with a number of players bankrolled by large strategics; among them Plasa - a joint venture between eBay and domestic carrier Telkom Indonesia - and Multiply, a social e-commerce platform acquired by Naspers with a view to cornering Southeast Asia. More recently, Japan's Rakuten has entered the space while Rocket Internet-incubated Lazada is looking to dominate fashion e-commerce in the region.

Despite this intense competition and a paucity of start-up infrastructure, Tokopedia raced through several small-scale venture rounds as its consumer-to-consumer (C2C) platform became the market leader, with 200% year-on-year growth rates and 2.6 million transactions taking place each month. The company struck gold - on paper, anyway - last October when SoftBank led a $100 million investment with participation from Sequoia Capital.

It is far and away the largest VC investment ever seen in the country's IT space. According to AVCJ Research, the next largest disclosed round is worth a mere $8 million.

For many in Indonesia, the deal represents a watershed for Indonesian venture capital. It gives industry participants confidence that the country has the talent and potential to deliver top-quality technology companies, encouraging entrepreneurs to build the next generation of start-ups and investors to support them.

Comparisons are inevitably being drawn between Tokopedia and its market-leading counterparts in Chinese and Indian e-commerce, Alibaba Group and Flipkart, even though the business models are not an exact match and Indonesia is at a much earlier stage of development. The energy and ambition is trickling down to every level of the market, conveying a sense that the early-stage ecosystem is entering a new dynamic phase.

"Since the Tokopedia investment by SoftBank and Sequoia, the game is has changed entirely," says Nicko Widjaja, an angel investor and program director at Indigo Incubator, a program set up by Telkom Indonesia. "A lot of VCs from outside the country have already set up bases in Indonesia, and they are looking at the country more seriously. What we are seeing now is quite different from when I started in this business back in 2011." 

 

Investors to set up shop include the likes of Singapore-headquartered Monk's Hill Ventures, which launched early last year and opened a Jakarta office in December. Thailand-based Ardent Capital created an Indonesia presence two months earlier. A host of local players have also emerged. In addition to Widjaja's Indigo Incubator, there is the recently launched independent firm Convergence Ventures (which was Convergence Accel but changed its name to avoid confusion with Accel Partners).

Growth engines

The increasing number of active players has inevitably led to a jump in disclosed early-stage deals. According to AVCJ Research, there have been eight transactions in Indonesia so far this year worth a total of $7 million, although the investment size was not disclosed in every case. In 2014 as a whole, $27 million was committed across 23 deals - the highest annual total on record. The previous two years each saw 14 transactions, though once again individual investment sizes tended not to be revealed.

"I think the ecosystem is already there - what is happening now is the fundamentals of Indonesia's internet economy are rapidly expanding," says Willson Cuaca, co-founder and managing partner at East Ventures. "If you look at it from the demand side, we have about 100 million internet users right now. Around 20% are engaged in e-commerce and this will increase to 40% in the next two years. That's around 30-50 million users, which is huge."

These estimates are broadly reflected in a recent report by Citi. In 2014 internet penetration in the Indonesia, which has a population of around 250 million, reached 33% - or approximately 83 million people - up from 29% in 2013. Come December the figure is expected to be 37%. By way of contrast, internet penetration in India and China is projected to reach 20% and 49%, respectively, by the end of 2015. Meanwhile, smart phone penetration in Indonesia will rise from 34% to 40%, or 102 million users.

This translates into massive e-commerce growth. The business-to-consumer (B2C) segment alone was estimated to be worth $2.6 billion 2014 and will expand to $3.56 billion this year. It has been a startling ascent from just $560 million in 2011, with compound annual growth of 59% over the last four years. Online ad spending is also rising sharply, with a total of $209 million expected in 2015, a more than five-fold increase from four years ago.

However, given that more capital is flooding into Indonesia to chase this growing opportunity, some early-stage investor are openly questioning whether there is enough supply to meet the demand.

"I think the market is ready but I am more concerned about the availability of start-ups worth backing," says Indigo's Widjaja. "When we did a search for entrepreneurs and founders on LinkedIn we found it was still small compared to Singapore or Malaysia. There were only 3,000-4,000 entrepreneurs, and of those only about 5% could actually be classified as investible."

Widjaja argues this is where incubators can play a key role in nurturing the start-up ecosystem, but the pool is relatively shallow. It is though there are only around 10 incubators active in the country at present, among them: Merah Putih Incubator, Jakarta Founders Institute, Batavia Incubator, and Gurpara.

The problem is the industry has yet to see proof of concept. Indonesia's technology space is still in its nascent stages, so there is no first generation of entrepreneurs to act as mentors and angel investors for up-and-coming start-ups. Furthermore, those independent incubators that do exist are resource-constrained so they are limited to small batches. This was one of issues facing Ideosource, which originally launched in 2009 with the intention of running an incubator.

"We looked at the incubation model but we didn't see that model as being quite scalable, it was just too early." says Andi Boediman, founder and managing partner of Ideosource. "So we decided we needed to do a seed model - and we since have deployed about $5 million to date in 19 companies."

Arguably, Telkom Indonesia's Indigo, as a corporate incubator, is able to draw from the deeper pool of capital and hence has scope to invest in more start-ups. According Widjaja, the incubator plans to back 40 entrepreneurs a year over two six-month programs. However, the program's primary purpose is to support companies that can contribute to Telekom Indonesia's own ecosystem, rather than helping companies scale up and become potential targets for later-stage investors. 

 

Turtle power

Despite an apparent dearth of mentors available to Indonesia's incubators, investors stress this does imply that the country lacks talent. Ideosource's Boediman believes the first generation of start-ups will likely be driven returnees who have spent time aboard - particularly in more places with more developed technology ecosystems such as the US and Japan - working for the likes of Microsoft and Google.

Peng Ong, managing director with Monk's Hill, likens Indonesia's tech expats to China's "haigui," or "sea turtles," who returned to the country after protracted stays abroad and helped develop private enterprises, both in the technology space and outside of it. He estimates there are currently as many as 10,000 Southeast Asian citizens in Silicon Valley. Returnees aside, the numbers are still stacked heavily in Indonesia's favor. 

 

"For example, China has 1.3 billion people, and if you take the top 0.1% you have 1.3 million very driven and very smart people," Ong explains. "It is the same with Indonesia. The overall population is smaller so that 0.1% amounts to fewer people, but it is still encouraging. I am not in Indonesia just because of the market opportunity; I am here because it has the largest pool of talent in Southeast Asia."

One stumbling block is that much this raw talent is not trained for the tech sector. Monk's Hill is trying to address this by backing the CS Leader Scholarship program, which supports computer science students in the hope that they can form the backbone of the start-up ecosystem.

The private sector is not alone in pursuing this objective. Last month, Indonesia's minister for communications and information technology unveiled plans to raise IDR12 trillion ($1 billion) from domestic conglomerates to develop the country's digital start-ups. It is not just a case of sourcing additional funding but encouraging companies to engage with the local ecosystem. However, industry participants wonder whether such an initiative is necessary. 

 

"What Indonesia has that countries like China lack are these large conglomerates that have made significant moves into the internet space, and have been doing a lot venture investing as of late," says Adrian Li, founder and managing partner of Convergence.

Indeed, Convergence is backed by the Bakrie Group, while Lippo Group has set up Lippo Digital Ventures, Ciputra Group is behind the Ciputra GEPI Incubator, and Sinar Mas Group has launched Sinar Mas Digital Ventures.

"To be honest we don't need that much capital support from the government when we lack enough quality start-ups, compared with the cash that is already available," says Ideosource's Boediman. "We don't need money from the government as much we need them to address regulatory issues."

It is a view shared by other industry participants. While markets like Singapore have sought to remove barriers to offshore capital, Indonesia is accused of being more protectionist. Of particular concern is the government's inclusion of online retail on the negative investment list, which essentially blocks foreign investment in B2C e-commerce start-ups. To get around this, fashion site BerryBenka and online jeweler Orori - both backed by venture capital - are among those to base themselves in Singapore.

On top of this, Finance Minister Bambang Brodjonegoro announced on February 1 that the government would impose a 10% value-added tax on e-commerce transactions. Tokopedia's Tanuwijaya has openly expressed concerns that this will discourage smaller merchants from using formal online platforms. Instead, they will probably go back to informal ones like social media sites and messaging apps that offer little if any consumer protection.

"There are also a lot of restrictions that means it takes a bunch of time to set up a company," adds Ong of Monk's Hill. "These things are intended to protect people but they are slowing down wealth creation, so hopefully they will get dismantled."

Bullish outlook

These regulatory hurdles may slow the development of Indonesia's start-up ecosystem but they will not derail it - the momentum is already too strong.

Convergence's Li - who hopes to reach a final close on his maiden fund of $30 million by the middle of this year - draws parallels between Indonesia today and China 10 years ago. To put that in context, in 2005, China had 103 million internet users, according to official statistics, and iResearch Consulting put total B2C e-commerce revenue at RMB5.6 billion ($896 million). Now the country has over 650 million internet users and B2C e-commerce is expected to be worth RMB15 trillion this year.

His optimism is share by East Venture's Cuaca. "It is scaling up fast and we don't look at the ecosystem alone," he says. "If you look at the fundamentals of what is going on inside Indonesia, I think everything is just right at the moment." (AVCJ)