Why startups fail

Not too long ago, the venture capital (VC) and tech sector was the place to be where employees were paid hands over fist. And then came the wave of popular startups shutting down. Recently, there have been rumours about layoffs in established tech companies. What happened?

Shifts in consumption patterns have been the first benefactor of digitisation — for example there are multiple ride-hailing options available instead of just the traditional rickshaws. However, Pakistan still lags behind countries, narrates Rabeel Warraich, Founder and CEO of venture capital fund Sarmayacar.

A number of funds came into the market from 2019 to 2022. However, the numbers were down 75 per cent in 2023, in line with the global phenomenon. In Pakistan’s peak years over 2021 and 2022, about $1.2 was invested per capita in terms of venture capital compared to $30 per capita for India.

“We are at less than two per cent digitisation for e-commerce compared to retail in the country. India is touching double digits. The UK, the US, and Germany are north of 25pc,” says Mr Warraich.

‘Too much money came in, creating certain habits that were not conducive for profitablity or sustainability’

For the longest time, Pakistan was not on the radar for international investors. When it appeared, there was a sudden influx of cash without sufficient stress testing of models. It also coincided with the ongoing bubble of cheap financing with high return potential because there was a lot of demand for VC but not a lot of supply.

When that capital made its way to startups, it developed certain habits which were not conducive to sustainable operations — the companies made a loss on unit economics. The startups were spending on ‘buying’ customers through marketing and offers, but they did not have a business model that could profitably retain those customers.

Quick commerce, business-to-business (B2B) commerce, and e-pharmacies were some of the early beneficiaries of VC funding that did not pan out.

Grocery shopping is a monthly trip with the family. Most people don’t care about getting groceries delivered in 15 minutes because they can send domestic help to the nearby kiryana store. Yes, a panicked order to get eggs and milk while baking might be placed through a grocery delivery app but these are tail items.

Given the slim margins, an average delivery value will n rake in enough to justify the cost of the platform, dark stores and logistics needed to fulfil the 15-minute delivery promise. Unless there is order density in each order location, and sufficient utilisation of the workers and vehicles involved in the process, the economics won’t work.

And while a lot was spent on building well-paid teams, discounts, not charging delivery fees and other incentives, the unit economics were not sustainable. As a result, scale intensified losses.

The intention was that once the customers were on board, the company could charge a higher price and make the model work, he explained. However, between the hit that disposable incomes took and the generally price-versus-value-conscious consumers, the model was not viable. People were not willing to pay a premium for speed or convenience.

“Too much money came in, creating certain habits that were not conducive for profitably or sustainability. Given the strength of the dollar, the need for $50 million rounds is questionable,” says Mr Warraich.

Keeping the consumer lens aside, there was also a case for businesses to get digitised. A flurry of capital flowed into the B2B supply chain e-commerce side.

“About $100 billion flows in through mom-and-pop stores. Potentially, a small efficiency gain can be made through leveraging technology. In a Utopian world, if a company can tap even 1pc of that potential, it can yield big returns,” he said, talking about Jugnu, one of Sarmayacar’s portfolio companies that was not a success in the B2B space. More than $150m flowed into six or seven startups to explore the same challenge over a relatively short period.

In reality, every day, the tech players would offer discounts on their platforms and the kiryana stores would simply choose the one with the best incentives with zero loyalty to any one platform. This model required large amounts of working capital since inventory had to be purchased, stocked and fulfilled. Razor thin margins, large working capital requirements, and low customer retention were not a recipe for success.

Similar challenges met the e-pharmacy side as well. On the business-to-consumer side, one of the hurdles was the price-controlled market. When discounts were offered, pharmacy owners snapped up the medicines rather than going to their traditional distributors, causing channel disruption.

The established distributors lost business and put pressure on some manufacturers to stop supplying to e-pharmacies.

Not all stories are of failure. SimPaisa is one of Sarmayacar’s success stories. It is a payment aggregator which acts as an intermediary for merchants on the Apple Store and Google Playstore to help them monetise payments and remit that capital. Processing millions of payments, the company generates over $1m in free cash flow every month. “And when we entered, our entry valuation was less than $1m. We anticipate over 50x returns on this investment,” he says.