India is home to more than 100 unicorn start-ups with a combined valuation of close to $350 billion. It is amazing that young entrepreneurs are finding multitude of options to create technologies and business models to solve a variety of socio-economic problems faced by residents of the country.

More than 70 per cent of these start-ups are digital platforms in various sectors such as transport, e-commerce, fintech, hospitality and tourism, food delivery, cab aggregation, healthtech, house maintenance, and beauty services.

This surge in Indian start-ups created flow of capital from Venture Capitals such as Accel, Blume, Kalaari Capital, Tiger Global, Nexus, Omidyar Network and Softbank to name a few. The start-ups with India focus provide adequate competition to the multinational ones and share significant part of their defined market.

This is the second wave of our IT and digital revolution wherein the digital start-ups are generating value as well as serving Indian consumers, much different from the earlier IT outsourcing revolution which we witnessed in the first wave. These digital platforms are typically Two-Sided Markets (2SM).

The theory of 2SM and associated platforms is not new. It has been in existence since the time Visa and Mastercard were discovered and even prior to that. In a typical 2SM, there are two sets of users who complement each other’s usage thereby increasing the network effect (aka cross-side network effect) for enhanced value for both.

The platform enables these two heterogeneous sets of users to come together to conduct commercial transactions. Success of the platform depends on the number of users on each side and the usage across them.

These digital platforms such as Ola, Phonepe, upGrad, and Myntra provide the required glue between commuters and drivers, consumers and merchants, learners and educational Institutions, sellers and buyers.

The challenges

In a relatively unorganized market such as India, there are considerable challenges to interconnect the two sets of users and that is where these digital platforms add tremendous value. These platforms through extensive data analysis, help discover the best match for the two sets of users they connect.

Once the connection is established between the buyer and seller, then additional analytic services such as cross selling, and up selling can be provided by these platforms. Typically, there are minimal entry barriers in these markets and hence there is good and healthy competition in the initial stages.

However, until the two sides scale up considerably the value of the platform remains minimal. Theorists have explained that the user adoption follows the nlog(n) model where n is the number of current set of adopters. This model results in S-shaped cumulative distribution of adopters with distinct initial low adoption phase to attain critical mass, followed by exponential growth and then the saturation phase.

We have been observing the following in the initial stages of adoption: (i) the platforms innovate new services enabled by technologies and provide deep discounts to bring in the early adopters; (ii) the regulators do not intervene to allow for the innovation to evolve; (iii) the investors are patient to provide hand holding to the start-ups to discover ways of building their platforms and user base.

However, during the growth phase, (i) firms need large amount of capital to scale up; (ii) the investors’ analyse unit economics of the firms and insist on profitability; (ii) the regulators starting to look at the platforms for regulatory compliance, competition issues and good corporate governance.

It is at the growth phase, that the platforms become fragile. Unless they scale up and become profitable, the investors find them to be unfavourable; on the other hand, the need for steep growth may steer the firms away from compliance and other moral codes of conduct.

Three principles

It is really important for the digital platforms to stick to the following principles while finding their way along the exponential growth curve.

First, it is important that they build and develop a trust relationship across the two sets of users they connect. Any trust deficit will lead to disgruntled partners, especially on the supply side, switching to other competitive platforms as the switching costs are typically very low.

Second, the founders need to inculcate the spirit of ethical marketing, customer acquisition and regulatory compliance so that they don’t deviate and come under the watchful eyes of the regulators.

Third, the management needs to focus on stable growth levels that are profitable. Large acquisitions, extreme diversifications, and super growth targets may not lead to the desired unit economics.

While it is typical of the firms to focus on growth at the expense of any of the three principles listed above, it is the duty and responsibility of the founders and the boards to keep tab on the above parameters to make sure that there is healthy growth. Those who don’t deviate on any of the above, survive and become the best!

It is an exciting time of digitization in India that we are seeing lots of entrepreneurial activity in the country. Most of these digital platforms solve very important social problems such as financial inclusion, educating the under-skilled, providing flexible work hours and employment, and improving livelihoods of many.

In the recent start-up ranking by Start-up Genome, Bengaluru and Delhi have moved up by a couple of spots, and tied with Sydney and Austin, US. respectively. We hope to see our start-ups and young entrepreneurs to break the glass ceiling and emerge at the top!

The writer is Professor, International Institute of Information Technology Bangalore