For the longest time investment into new ideas was concentrated almost exclusively within the USA and Europe. Now, funds and companies around the globe are observing a global shift of investment from traditionally developed western economies to what are now the economies of the future. Below we will show some of the key ways that emerging markets are changing the way investors operate in the region.
Written by: Tanay Sonawane, Jonathan Ouyang and Filip Vrábel
Local Solutions for Local Challenges
Venture capital has long been associated with innovation and economic growth, predominantly in developed economies. However, the landscape is evolving, with a noticeable shift towards emerging markets. In recent years, investors are recognizing the untapped potential and unique opportunities that lie within these regions. The main reasons cited are the ‘demographic dividend’ of many of the biggest emerging economies - the enormous amount of young people which are able to become a reliable consumption base without having to provide for a bigger retiring generation like in the developed world - or diversification. "Local Solutions for Local Challenges" encapsulates the essence of this shift, emphasising the need for tailored approaches to address the specific challenges faced by businesses and normal people in emerging markets.
One key aspect of this is the emphasis on understanding and adapting to the local context. These markets often present distinctive challenges, including regulatory complexities, limited infrastructure, and cultural nuances. Successful VC initiatives in these regions prioritise local knowledge, leveraging insights into the market dynamics and building relationships with key stakeholders. This not only facilitates smoother operations but also enhances the ability to navigate challenges specific to each locality.
Take for example “Harvesting”, an Indian startup with the motto ‘Leave no farmer behind!’ . The project centres on establishing market connections for 120 million smallholder farmers all across the Indian subcontinent through grassroots initiatives and the integration of data and technology. It has already successfully unified 3.7 million farmers on a shared platform, aiming to render smallholder farming economically viable. That success comes from a deep understanding of the agricultural sector that Harvesting is dealing with - an uninformed investor could prefer to look for a farming startup focusing on intensive rather than extensive farming methods (ie industrial, corporate and machine rather than labour intensive) but Harvesting understands that it is its commitment to smallholder farmers which has provided its current success. Those farmers can now vend their produce and access customised financial products and agricultural inputs. That seems a much more useful outcome than trying to fund a mass-scale corporate farming industry which would not offer the current producers (who are smallholders) anything.
Another factor is the focus on sustainable and inclusive growth. Investors are increasingly recognising the importance of supporting businesses that address local challenges, from healthcare and education to agriculture and technology (a good example is the above-mentioned Harvesting). By investing in enterprises that provide innovative solutions to these challenges, VC firms contribute to the overall development of the community while generating profitable returns. This dual impact aligns with a broader trend towards socially responsible investing in emerging markets.
Take for example, Nigerian startups supporting sustainability. Wecyclers is a Nigerian-based for-profit social enterprise that promotes environmental sustainability, socioeconomic development, and community health. On its website, it shows awareness of both the great growth prospects and the sustainability problems arising out of it, stating that “while Lagos is on track to become the third largest economy in Africa, 8.5% of its population is still poor and an additional 20% are vulnerable to poverty”. The solution is “rewards-for-recycling platform that incentivizes people in low-income communities to capture value from recyclable waste” which are offered by Wecyclers, showing its potential to address environmental and social concerns.
A similar example is WasteCycle, another Nigerian recycling startup which leverages technology to solve waste-related problems.
The surge in startup activity in emerging markets signifies a departure from conventional investment frameworks. "Local Solutions for Local Challenges" encapsulates the essence of this approach, emphasising the importance of understanding and addressing the unique hurdles faced by businesses in these regions, whether that be the economic structures, such as the agricultural sector in India (as with Harvesting), or the social and environmental concerns that come with operating in low-income climate stressed areas (as with the Nigerian waste-collection startups). By fostering sustainable and inclusive growth, venture capital can not only benefit investors but also play a pivotal role in shaping the future of emerging market economies.
Corporate VC across emerging markets
In recent years, there has been a notable surge in investment activity within Emerging Venture Markets, reaching a substantial milestone of over $7 billion deployed in 2022. The surge in funding is attributed to a growing pool of regional and international investors, with their numbers nearly doubling since the post-pandemic era. 2021 witnessed a significant uptick, with the total count of investors in emerging markets reaching 1072, creating a remarkable year-on-year increase of 72%. Amidst this dynamic landscape, venture capitalists have long been prominent supporters of the ecosystem, but the evolving space now includes participation from big corporates, investment companies, accelerators, and corporate venture capitalists.
Over the past five years, there has been a nearly threefold increase in Corporate VCs investing in startups. Although the number of CVCs may be comparatively fewer than traditional venture capitalists, their role is pivotal, offering corporations a promising avenue to penetrate the tech space. Recognising the importance of staying at the forefront of innovation, corporations increasingly view external startup investments as a mutually beneficial strategy, contrasting the traditional approach of building innovative setups internally. Corporate VCs provide startups with invaluable industry insights, access to potential customers, and crucial financial backing, especially during periods of constrained capital flows and cautious investors. This symbiotic relationship not only grants startups access to the parent investment company's assets but also augments the sales and profits of the corporation's existing businesses, with the potential for an easy exit in the future through acquisition by the parent company.
Balance Sheet investments: investments made directly in investee companies without leveraging holding companies or funds - for instance, PLDT’s participation in RocketInternet Holding or Digicel’s investment in Boom Financial. As an example, PLDT has been able to contribute the intellectual property, platforms and business operations of its market leading mobile-first payment platform Smart e-Money Inc. (a pioneer in mobile banking and mobile wallet services which has handled transactions valued at approximately EUR 3.4 billion in 2013) - these are clear ‘established brand’ advantages the local environment would struggle for years to develop by itself.
Directly managed CVCs: Fund set up by mobile operators as entities separate from their telecom business, basically a way for operators to invest their profits in a structured and systematic manner, while ensuring a certain degree of control over the direction of the fund. Examples include Singtel innov8, Axiata Digital Innovation or Telekom Indonesia MDI Ventures Fund. Telekom is the perfect example here, since as a globally recognisable brand, it is obvious why it has the pockets to finance startups in emerging markets and would also have the incentive to do so. Its industry expertise and brand name would also make it a more attractive source of funding than a non-corporate VC.
Indirectly managed CVCs: Similar to the previous model; in this case the fund is managed by an external party, traditionally an expert venture capitalist. Examples are STC VENTURES fund handled by Iris Capital or Spark Venture Fund managed by TBL Mirror Fund. These are in essence almost the opposite of our Telekom example above. They thus obviously do not provide the advantages of corporate VCs to such a degree - after all the brands are not directly involved - but an argument could at least be made that without the involvement of CVCs, such money would not be put together in the first place.
As we move deeper into a global technological revolution, it should be no surprise that emerging markets are now rapidly becoming the new frontier for digital infrastructure. While these markets may each face unique challenges in fully exploiting the powers of digital transformation, evident by the wide disparity in infrastructure across regions and socioeconomic groups in these countries, the start of the transformation is quite promising.
To start at the top, digital transformation became increasingly relevant in emerging markets first during the COVID-19 crisis. The global pandemic has highlighted the crucialness of digital connectivity, not only for societal resilience, but also for business continuity and economic well being. As a result, we are now seeing a surge in the demand for this connectivity. Yet, an issue at the time, particularly in emerging markets, is the effect of negative economic shocks that have led to smaller relevant companies, thus reducing competition and technological innovation. With a trend of funding withdrawals during the same period, it seemed as though a digital transformation was somewhat far-fetched for developing countries.
However, the narrative is not all bleak. As the emerging markets themselves started to emerge from the abyss of the pandemic, we began to see the burgeoning opportunities for investment and public-private collaboration. In early 2021, Egypt’s shift to digital infrastructure led to an increased demand of ICT services, prompting the government to initiate relevant support projects, and granted US$19.1M to fund further projects. Saudi Arabia’s intensified commitment towards a digital agenda was included in the country’s development strategy towards 2030. Peru’s increased digital innovation across sectors such as mining, agriculture and financial services have also started to pay digital dividends.
To continue, in 2022, IFC investments in the TMT sector totalled US$1.3Bn, reflecting the immense growth opportunities in the TMT sector across global emerging markets. It is reported that Africa’s internet economy may reach US$180Bn by 2025, accounting for 5.2% of the continent’s GDP. Indeed, this synergy is crucial in fortifying the digital infrastructure and subsequent financial inclusion.
The startup landscape in emerging markets are also looking promising. The company Liquid Telecom in Africa has now started to provide comprehensive fibre connectivity across the continent. Indeed, with foreseeable expansions in the overall market, we should witness a bridging of the digital divide in emerging markets, thus successfully fostering economic growth driven by digital innovations.
Shifts in consumer behaviour in emerging markets
Once again, the sheer scale of the pandemic has transformed consumers’ behaviour and spending priorities. There are several changes, particularly in emerging markets that we can take note of.
Firstly, consumer demand has plunged in categories such as clothing, cosmetics, and public transportation. With regards to public transportation, consumers’ need for safer, and thus private transportation, may have fuelled this reduction in demand. Subsequently, the demand for cars, scooters, bicycles showed great increases.
Secondly, the greater concern for health has increased the demand for healthier foods and other supplements by 34% and 42%, respectively. Indeed, the dormant life during the pandemic has no doubt been a wake up call for many as a sign to improve their physical activities and take care of their overall physical and mental health.
Lastly, and perhaps most obviously, the pandemic has induced new shopping habits, centred around digital use. Namely, consumers have shopped more from online retailers, buying more from chat groups, using digital wallets, and increased their subscriptions for streaming apps. The demand for all of these services have increased by an average of 50%.
And indeed, the above consumer behaviours seem to be sticking more than a year later! However, we also saw “blips” in the rise of demand for some goods and services.During the height of the pandemic, sales surged for categories such as mobility services, staples and health insurance. However, this rise in demand seemed to be short-lived as the demand waned through ensuing waves of the virus.
Indeed, the pandemic has induced somewhat of a seismic shift. Understanding these shifts is no doubt crucial for businesses that are aiming to thrive in emerging markets. Tapping into consumer’s belief systems and adapting to these evolving habits is thus becoming a key part of shaping successful marketing strategies.
It would be a wise assessment to say that emerging markets will define the technological, commercial and financial advances made by future generations. From shifting consumer behaviours to the innovation of companies to solve local problems, we encourage all investors to pay very close attention to what happens in these regions next.