Korean start-ups: Pursuing critical mass

From "Gangnam Style" pop culture to beauty balm creams, Asian consumers have developed a taste for Korea. But when Dino Ha, founder of cosmetics online retailer Memebox, tried to raise capital from domestic VC investors three years ago, few were willing to buy into this notion that a Korean start-up could go global from the very beginning.

Ha, who previously worked for global fashion brand Tom Ford and then South Korean e-commerce platform TicketMonster, turned his attentions to the US. He submitted his business model to Y Combinator and Memebox became the first - and so far the only - Korean start-up to be accepted into the accelerator program. In March, the company closed a $17.5 million Series B round from a group of Silicon Valley-based investors including Formation 8, Goodwater Capital, AME Cloud Ventures and FoundersClub. The valuation was said to be $100 million.

More than 70% of Memebox's employees are based in Korea, but its website is entirely in English so as to focus on overseas customers. The company has already expanded into the US and China, and plans to add four more Asian countries to its coverage next year. By 2018, the aim is to be in 12 markets.

"The start-ups ecosystem has changed over the years. When Coupang launched in around 2010, it could focus on the domestic market but now you need to be a global company from day one," says Ha. "For a start-up, you either build a company that's going to be worth billions of dollars or you just stay small. We are building infrastructure with small teams in each country so that we can scale up in the future."

E-commerce player Coupang recently received a $1 billion investment from SoftBank Corp. that values the business as $5 billion. Alongside mobile start-up Yello Mobile it is one of several companies to achieve "unicorn" status, or a valuation of $1 billion or more. A clutch of start-ups in different specialist verticals - including Memebox - are tipped to join the club at some point over the next couple of years.

These companies have benefited from the flood of capital entering the technology space in order to latch onto ideas that target an incredibly mobile-centric market. Nevertheless, Korea's population is limited in size and this raises the question as to how many unicorns the country can support and in what areas they are likely to thrive. Should the rest follow Memebox's lead and go global?

Momentum plays

Venture capital investment in Korea stands at $2.8 billion so far this year across 54 transactions, compared to $1.6 billion and 155 deals in 2014. The marked increase in average transaction size is explained by the way momentum has gathered for a select few players. When Sequoia Capital committed $100 million to Coupang in May 2014, the valuation was more than $1 billion. Six months later BlackRock Private Equity Partners led a $300 million round at $2 billion. And then two months ago SoftBank entered the fray.

These rising valuations have tracked rising sales. Coupang achieved $1 billion in annual gross merchandise value (GMV) within three years of launch, supposedly faster than any other firm globally. GMV is now rising 80% year-on-year and the firm has an annualized revenue run rate of $3 billion. At least 70% of users access its services via mobile devices.

The start-ups ecosystem has changed over the years. When Coupang launched in around 2010, it could focus on the domestic market but now you need to be a global company from day one - Dino Ha

This success is based on the fact that mobile apps relying on widespread demand for convenience are more likely to gain traction. There are about 50 million people in South Korea, and one in five of them lives in Seoul. The combination of high population density and mature middle-class consumers make for an ideal testing ground for mobile services.

Smart phone penetration is the fourth highest in the world, according to mobile carrier KT Corporation, and online sales came to KRW45.3 trillion ($38.5 billion) last year, up 80% from 2010. Nearly two thirds of sales were generated by online-only malls. Mirae Asset research estimates that mobile commerce will achieve 40% penetration by 2017, up from 2% in 2011.

Start-ups operating in different verticals have also seen rapid growth. Woowa Brothers launched its food-ordering platform - Baedal Minjok - in June 2010 and has since accumulated 140,000 customer restaurants nationwide. It processes more than five million orders per month and the Baedal Minjok mobile app had been downloaded in excess of 19 million times, equivalent to more than half of Korea's entire population.

Goldman Sachs invested in Seamless, a US-based food ordering platform that merged with rival GrubHub in 2013. The combined entity went public later the same year, raising $192 million. It then led a consortium that committed KRW40 billion ($36 million) to Woowa in November last year, when the company already had a more than 60% market share.

Goldman was convinced by Woowa's business model, which was initially similar to that seen in the West: the food-ordering platform is an intermediary between customer and restaurant, and plays little or no role in the delivery process. Woowa now takes responsibility for deliveries and is investing in its logistics system, including the recruitment of motorcycles and drivers. This now means it can deliver a wider variety of fresh foods.

"Woowa's core business is growing fast. They now have a last-mile delivery capability, delivering fresh food like sashimi and sushi. They have also developed another business called Woowa Fresh, which provides ready-to-cook types of food ingredients right to the door. And they now have a cold chain logistics system following several recent acquisitions. It is a combination of organic and inorganic growth, and the story is very exciting," says Jay-Hyun Lee, Korea lead for Goldman Sachs principal investment area.

In this way, online food delivery is a highly territorial business and it is difficult for domestic e-commerce marketplaces like Coupang or international competitors to enter the market. Coupang has branched out into a lot of consumer verticals, such as beauty products and clothing, and it is developing its own delivery services, but the offline logistics system is totally different from food delivery. The latter relies on cold chain and last-mile delivery by motorcycles, while the former uses truck fleets.

These sophisticated, homegrown champions present an enormous challenge to global players that set their sights on localized services in Korea. Ride-hailing app Uber tried to expand into the country but was soon squeezed out when Kakao Talk, Korea's largest mobile messaging app, launched its own taxi-hailing service. Yello Mobile, which has aspirations to become a multi-platform internet company along the lines of US-based IAC, bought up more than 100 local mobile internet companies and is now looking for similar assets in Southeast Asia.

"There will definitely be more unicorns. If you think about the full value chain, almost anything can be turned into an online-to-offline market, whether it is a taxi-calling app or a cosmetics online retailer. There will be many category killers that create their own markets rather than just become large commoditized platforms. It is a matter of how each player can defines its own market, how it sets up barriers to entry," Lee says.

Changing times

Before 2005, South Korea's internet infrastructure was more advanced than that of the US in areas like social networking and gaming. But these positions were reversed as a result of the smart phone wave, whereby start-ups can launch businesses based on iPhone's iOS or Google's Android operating systems. Tae Hea Nahm, managing director of US-based Storm Ventures, notes that Korea still has no dominant player in numerous categories, such as Airbnb-style vacation rental service providers.

While established investors such as Blackrock Private Equity are more likely to invest in companies after they become unicorns, a number of VC investors see a value-add opportunity in building Korea-US exposure so they can help category leaders in Korea pursue global expansion. Altos Ventures, Kingsbay Capital and seed investor Strong Ventures have all adopted variations of this approach. Last year, US-based VC firm 500 Startups also launched a fund to invest in Korea.

In addition to identifying trends in the US that are relevant to Korean start-ups, these investors can also bring in US VC investors to back their portfolio companies. Strong Ventures, for example, participated in an angel round for bitcoin exchange Korbit alongside several Silicon Valley-based players, including Tim Draper. Then it invited SoftBank and a US hedge fund Pantera Capital to join the Series A round. Strong also introduced DCM and Formation 8 to Tumblbug, a Korean crowd-funding site, which resulted in a Series A round.

"Instead of waiting for Coupang to become a billion-dollar company and then get blue chip Silicon Valley venture capitalists on board, we accelerate the process and get those blue chip investors involved in Korean start-ups from a super-early stage," says John Nahm, founder and CEO of Strong Ventures.

It all depends on which verticals are you focusing on. Some domestic markets are large enough; you really don't need to have an overseas market to focus on. And then there are some where you absolutely need an overseas market - Han Kim

Although Korea is large enough to support a handful of unicorns in different segments, the market is a fraction the size of the US or China. As such, existing unicorns seek growth overseas. While Coupang has hired a Chinese CTO as it considers expansion into China, Kakao is making its acquisitions in Southeast Asia. However, just as global companies struggle against strong local incumbents in Korea, so the Koreans will have to take on competitors overseas.

Earlier this year, Woowa announced a joint venture with Line Corporation to offer food delivery services to Japanese diners. However, the management team is cautious about entering a new market due to the need to replicate the offline logistics it has built at home. The collaboration with Line is therefore nothing more than a pilot program.

Coupang faces a similar dilemma. The bulk of Sequoia's $100 million round was earmarked for logistics - warehouses, truck fleets, and "Coupang men" to handle last-mile delivery - and it is likely that more funding will be channeled in this direction. Creating this kind of delivering infrastructure overseas would require a lot of time and money.

"It all depends on which verticals are you focusing on. Some domestic markets are large enough; you really don't need to have an overseas market to focus on. And then there are some where you absolutely need an overseas market," Han Kim, founder of Altos Ventures.

To the extent that Korea can monetize its cultural cachet - whether it is cosmetics, food or television dramas - in markets like China and in Southeast Asia, the cross-border angle might gain traction. If a start-up has a product or service for which consumers in overseas markets are willing to pay a premium because they can't get it elsewhere, then is it possible to achieve sustainable scale.

Memebox now sells private label products, which are a key revenue driver, in outlets of Hong Kong-based Watsons and Sasa. The company wants to partner with 100 Sasa stores in Taiwan and 80 in Hong Kong by 2016. It currently has a portfolio of 5,000 of self-developed products, produced in China by Korean manufacturing partners.

"It is very difficult to compete with local players on the service level, but I think we have products that customers are looking for," Memebox's Ha says. "For example, Chinese e-commerce platforms sell close 30 brands of Korean beauty products, but on our platform we have 970 brands. The reason we just focus on beauty products is that it isn't just about branding and marketing, but also manufacturing quality products."

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• Topics
• North Asia
• Venture
• Technology
• Consumer
• Expansion
• Venture
• South Korea
• TMT
• Consumer
• Goldman Sachs
• Formation 8
• Altos Ventures