Indonesia tech: Sleeping giant

Indonesia is considered unique among Southeast Asian markets for having the sheer size to support the creation of domestic technology giants. The country’s similarities with the rest of the region, however, may ultimately be the deciding factor in how its economic development story unfolds.

Some of the most recent action in this space has also been the most visible. Last month, local ride-sharing app and delivery player Go-Jek raised a $1.5 billion Series E round from a slew of top names including Tencent Holdings and Google, earning the start-up a valuation of around $5 billion. Grab, a Singapore-based competitor that operates primarily in Indonesia, quickly countered with the acquisition of the Southeast Asian business of global segment leader Uber. 

This rivalry has helped put Indonesia’s fledgling technology economy on the map and supported faith in the thesis that the country’s population of some 260 million consumers will precipitate a China-like macro story. But regionally familiar challenges around geographic fragmentation, insufficient infrastructure, and widespread shortages of economic resources remain important checks on the ability of VCs to grow companies based on such hopes.

“The kinds of businesses you need to build to target the bottom of the pyramid are different because people’s problems are different,” says Nikhil Kapur, a principal at Gree Ventures. “Almost half of them are farmers whose income in a day is what a Go-Jek driver earns on one ride. So how can they use Go-Jek? They cannot. They walk.”

For investors, this viewpoint highlights a critical distinction between Indonesia’s digital ecosystem and the digital economy. Kapur sees the ecosystem as widespread, with perhaps 100 million people mobile-connected and using social media. The economy, he estimates, is restricted to only 10 million people willing and able to make purchases online. For companies such as Go-Jek, which claim a footprint across more than 120 cities, this suggests a starkly uneven dissemination. 

Gree is tackling the issue by increasingly targeting businesses that cater to the bottom and middle of the economic pyramid such as Kudo, a $100 million online-to-offline financial services provider the firm backed in 2015 and exited to Grab as part of the ride-hailing company’s gambit to access the unbanked market. Gree’s key investment in the country, however, remains Bukalapak, an online marketplace said to be worth in excess of $1 billion despite being limited to a digitally savvy consumer base of 10 million.

Market targeting

The seeming incongruity in some of these estimates helps illustrate why defining the accessible market for technology-enabled companies in Indonesia is by no means an exact science. Internet penetration is around 70% in urban areas and close to 50% in semi-urban and rural areas. This requires marketing efforts outside of the main population centers on the island of Java to include a more expensive offline approach, which in turn makes nationwide expansion all but impossible for the smallest companies. 

All of Indonesia’s so-called unicorns – start-ups with valuations over $1 billion – are pushing beyond the 140 million people that make up Java, including the 25 million shoppers in the greater Jakarta area. But even in relatively built-up tier-two and tier-three cities, these companies remain constricted by an ingrained cultural wariness around online payments and poor levels of bankability. 

According to Bain & Co, end-consumer online spending in Indonesia reached $12 billion in 2016, the biggest portion of which by far was in e-commerce and travel. E-commerce gross merchandise volume was around $5 billion during 2016 but went up to about $12 billion the following year as a number of government modernization programs solidified, including a fiber optic installation project that aims to connect some 540 cities by 2020. 

“It’s difficult to speak with certainty about the true total addressable market and whether all of these macro development plans will take shape in the time period they are expected to,” says Usman Akhtar, a partner with Bain & Co in Indonesia. “That said, the number of digital consumers in Indonesia was 83 million in 2017, up 35 million from the year before. That’s not a trivial number, and it’s going to keep growing.” 

Earlier this month, the Asian Development Bank (ADB) found Indonesia’s economy grew at 5.1% in 2017 and forecast 5.3% growth across 2018 and 2019 on the back of rising foreign direct investment and household consumption. In the long term, much of the projected progress hinges on infrastructure improvements, which Natixis estimates could push growth rates past the 7% mark if fully realized. To date, however, most development work is being shouldered by state-owned enterprises (SOE), stoking both concern and optimism about the uptake of efforts to reduce debt through more progressive monetary policies.   

“The government seems to have employed SOEs quite a bit to expedite the implementation of its ambitious infrastructure agenda. That’s not necessarily a bad thing, as long as project selection and preparation are sound and the private sector is not crowded out,” says Winfried Wicklein, ADB’s country director for Indonesia, noting a rapid increase over the past couple of years in the number of public-private partnerships under construction and in the pipeline. “A number of infrastructure SOEs seem to have reached capacity limits, so there’s an increasing effort to seek innovative financing approaches, and at the same time more space for the private sector is opening up.”

Developments around infrastructure and new financing approaches are seen as essential stepping stones to accessing the isolated populations that make up the majority of the Indonesian opportunity set. Indeed, the largest technology start-ups, including Go-Jek, Bukalapak, travel search engine Traveloka, and online marketplace Tokopedia, are believed by most investors to boast valuations predicated largely on presumed future access to still untapped rural markets.

For the retail-related areas that have demonstrated scaling potential to date, this puts significant pressure on actually realizing physical expansions across a notoriously disjointed archipelago. “The valuations are based on a market of 260 million people, but the reality is that Java is about 60% of that,” says Roderick Purwana, managing director at Jakarta-based SMDV. “If you look at some of these services like e-commerce, the opportunity is really outside of Jakarta. If you are in Papua, that’s where e-commerce really makes sense.”

Java remains a heavy anchor on the start-up ecosystem, however. Even companies that specialize in addressing rural populations, such as Kudo, are managed almost exclusively from bases in the Jakarta area. Each province is said to have its own locally unique combination of logistical levers for opening a digital market.

Financial push

Increasingly, these obstacles are not viewed as a lack of bridges, roads and telecom towers. Instead, Indonesia’s top start-ups see financial inclusiveness as the critical bottleneck in customer acquisition. Go-Jek, Grab, Tokopedia, Traveloka, and Bukalapak have all advanced aggressive financial technology programs, including e-wallets, payment apps, and loan services. These efforts have paralleled the evolution of a range of novel technology-based economic enablers for offline consumers.

“Infrastructure is one of the issues in Indonesia, but the problem is much more difficult than just improving internet connectivity, because only 20% of the population has a bank account,” explains Elisa Suteja, a senior analyst at East Ventures. “That’s why companies are trying to grow in a way where they don’t have to rely on the banks in order to tap into the market outside of Java.”  

East Ventures, which has backed both Traveloka and Tokopedia, has made a priority of supporting micro-entrepreneurship and helping start-ups adapt their businesses for markets beyond Java. The firm claims to have contributed to 50% of the country’s deal flow and more than 70% of local companies that have received Series A funding. 

“Everyone in Indonesia faces similar challenges of how to change customer behavior from offline to online, but if you need to educate people every time you expand into a new market, it can be very costly,” adds Suteja. “The better way is to target people who already understand the product and create a bandwagon effect. As a tech company, you should grab the lower-hanging fruit.”

In this light, the fintech forays of the larger start-ups can be seen as part of a cultural process. Indonesian unicorns are not only expanding financial inclusion to rope customers into their core business: they’re establishing trust and redefining the infrastructural framework of the new economy. It’s a commercially motivated race to win consumer loyalty, but for the most geographically dispersed operators, there is significant potential to effectuate systemic social evolutions.    

Khailee Ng, a managing partner at 500 Startups, notes that Bukalapak does most of its business in less developed areas, including a number of remote islands. This strategy leverages both Indonesia’s macro-level growth story and the personal ambitions of isolated buyers and sellers keen to expand their reach through technology. “Having a long tail – that’s how you get the network effects,” Ng says. “Bukalapak is playing a long game by focusing outside of Jakarta.”

The investor opportunity cuts across three basic approaches: homegrown businesses that cater exclusively to the local market such as Go-Jek; domestic companies looking to expand regionally such as Traveloka; and offshore players focused on leveraging the Indonesian market such as Grab. 500 Startups has played a number of these angles, having backed Bukalapak, Kudo, and Grab, among others. Larger private equity houses tend to gravitate toward the foreign-headquartered entrants, although KKR and Warburg Pincus began investing Go-Jek as early as 2016.

Unicorn watch

Much of this activity reflects VC industry eagerness to pick the country’s next unicorn in its early stages. Although Indonesia’s next inflection point of large start-up creation may be a decade of economic development away, most investors expect another breakout player to emerge within three years either in the form of a standalone fintech services provider or a B2B facilitator. 

Meanwhile, agriculture, which has historically represented 15% of national GDP, is seen as arguably the most underdeveloped industry and ripe for technological disruption. Earlier this year, IT Minister Rudiantara, who uses one name, predicted the education sector would generate the next nationwide success story. He singled out Ruangguru, an online tutoring service backed by East Ventures, Venturra Capital and UOB Venture Management, as an interesting prospect. 

In healthcare, government intervention is believed to have sparked company creation – Go-Jek-backed HaloDoc and 500 Startups-backed Alodokter being notable examples. However, the ability for companies in any sector to expand across the country cannot as yet be juxtaposed with the rollout of policy improvements.

The disconnect is exacerbated in a number of other promising areas, including modern warehousing, where investors consider growth potential to be dependent on government support including the setting up of special economic zones. As a result, there is some concern around the political uncertainty implied by the general election set for 2019.

Investors have signaled a preference for a more Singapore-style policy environment, where new technology-enabled business models are monitored closely but with a relatively light touch. This approach is seen as more supportive to the new fintech verticals that are aiming to unlock Indonesia’s unbanked population but suffering from regulatory bureaucracy and a relative lack of licensing options.

“It’s always easier for the bigger companies to get their foot in the door, lobby and get a license, but it’s much more challenging for the smaller start-ups,” says Gree’s Kapur. “That’s where the key lies because you ideally want 100 companies trying to solve this problem in many different ways for it to actually succeed. We can’t just focus on the unicorns as the ones that are going to solve it. They have their own agendas.”  

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• Topics
• Southeast Asia
• Technology
• Consumer
• Financials
• Indonesia
• Gree Ventures
• Asian Development Bank
• Sinar Mas Digital Ventures
• East Ventures
• 500 Startups
• e-commerce
• Transportation
• Financial Services