Early investors in consumer start-ups have secured good exits and returns, says Deepak Shahdadpuri, founder and managing director of DSG Consumer Partners

Early investors in consumer start-ups have secured good exits and returns, prompting several funds to enter the space they had traditionally ignored, says Deepak Shahdadpuri, who leads venture capital firm DSG Consumer Partners (DSGCP), which recently achieved the final close of $50 million for its second fund.

“It is good to see recognition for the sector, but the consequence is valuation inflation where many seed and Series A deals are priced to perfection and do not appropriately price in the risk of such start-ups,” Shahdadpuri added. Edited excerpts:

You have been talking a lot about the emergence of challenger brands in India to take on big entities in packaged consumer goods sector. How do you see this space in 2018? At what stage are the challenger brands right now, and how challenging will it be for them to scale and take on the big companies going forward?

We are at the very start of the new brand movement in India. I classify new brands as, first, challenger brands; second, niche brands, and third, follower brands. Challenger brands compete with existing incumbents. Niche brands launch offerings in white spaces in the market. Follower brands follow the path of a leader or a successful challenger or niche brands. Sometimes, niche or challenger brands can become market leaders just like Sula (a wine maker) did over a 10-year period. There is a confluence of factors—some global and some local—that is driving the trend favouring new brands. Foremost is their ability to directly meet consumers’ new and ever-evolving demands.

Consumer-inspired trends remain the driving force for the products and services offered by FMCG (fast-moving consumer goods) start-ups. The new consumer is more individualistic, cares about provenance, wants to be engaged with the brand experience, likes better for-me products, demands personalization and wants to make a social impact. The Indian millennial consumer wants to support the new brand with a more relevant social message that communicates directly with him. Entrepreneurial agility and the ability to take risks, learn fast and maintain a steady flow of innovative product releases is essential and this cycle needs to be continuous.

We have seen many new brands over the past decade. Some great examples doing this are Paper Boat, Chai Point, Raw Pressery, Epigamia, Spotted Cow Fromagerie, Veeba, Sleepy Owl, The Mom’s Co, Eazydiner, Fogg, Green Snack Co. and TGL Teas. We are at the beginning of the consumption S-Curve, as India’s per capita discretionary spending accelerates. The Indian consumer today is proudly Indian and wants to indulge in Ayurveda and Yoga, for example.

Many trends are global and what works in the US and Europe may work in India. I expect to see more new brands launch in 2018 and beyond as they look to either address white spaces where there was no current offering—for example, Epigamia launching India’s first Greek yogurt, or where they are offering a new value proposition, like Raw Pressery’s fresh cold press HPP (high pressure processing) juice challenging long-life UHT (ultra-high temperature processing) juices.

We will also see a lot more focus on locally manufactured and sourced products. There is no need to buy imported Brie after you try Spotted Cow’s cheeses.

Scaling will be a challenge. The product and manufacturing are usually the easiest part. The most difficult is distribution and marketing, especially if you enter a category where you are fighting against large MNCs (multinational companies) such as Unilever, P&G (Procter & Gamble Co.), Kelloggs, ITC and others. What is interesting in developed markets is that the FMCG majors have seen the impact of new brands.

These new brands have taken material market share and have been unable to innovate in the manner the consumer expects. There has been a narrative that speaks about how MNCs have lost their way and struggle to connect with the next generation consumer. I think this has been overplayed and many of them have re-engineered their portfolios to target new growth areas. However, there is still a very strong trend among millennials to support the new underdog brands against the incumbent MNCs. Consumers want to support the new local start-ups.

MNCs have started acquiring challenger brands and investing in programs alongside challenger brands. I have met senior executives at many of the large FMCG majors and they will be the first to admit it is difficult for them to create an environment that allows new brands to emerge. Their solution was to work with start-ups, whose growth rates were far better. Initiatives are very broad, from incubating new brands, investing in challenger brands and working with brands and allowing them to leverage the major’s platform. Some have even started venture funds to invest in challenger brands or adjacencies. Examples include Unilever Ventures, Kellogg’s new initiative Eighteen94 Capital, General Mills’s 301 Capital, and there are many more. However, corporate venturing is tough to do as it forces majors to do exactly what they have been conditioned not to.

India’s food services sector is seeing the return of private equity (PE). What is your reading, considering that this space has seen a slew of deals in 2017? Was it because PE firms flush with capital were looking at increased avenues to deploy, leading to more deals?

There has been an unprecedented interest in food services over the past six months. We have seen deals at Riyaaz Amlani’s Impresario, Zorawar Kalra’s Massive Restaurants, Wow Momos, JSM, AD Singh’s Olive, Theobrama and more. The food services market is very large and as GDP (gross domestic product) grows, we can expect per capita consumption on food services to grow more quickly. However, very few VCs have made money in food services in the last cycle. The industry is burdened with cumbersome regulation from food safety to licensing to ongoing harassment by local authorities that make operating and scaling food services businesses very difficult. I have backed Social, Burger King India, Suzette and Kitchen Garden and continue to believe in the long-term opportunity, but we need to see more done at the ground level to make it easier to operate.

Investment side apart, what are the trends that will be shaping India’s food industry in 2018?

India will follow most of the global trends. Some of these include traceability, clean label, provenance, better for me, plant-based foods and beverages, dairy alternatives, functional products, e.g. protein, calcium, probiotics, organic, natural, convenience, less or no sugar and the list goes on. Households no longer make one meal or share the same product for the whole family. For example, in the same household, some are vegetarian, some are focused on proteins and others want to eat organic. Same for personal care as they buy multiple types of toothpastes, creams and shampoos. The grocery basket needs to cater for all of them. This provides a large opportunity for new brands to create specific products for each consumer demand.

Suddenly, there seems to be a lot of interest in consumer brands, compared with earlier when just a handful of investors were active in this space. But as more investors pile in, and as valuations increase, will it face same challenges as that of other sectors?

Despite the FMCG sector being a very large and obvious sector for disruption, it has been generally ignored over the past decade by the investors, particularly at the venture stage. So I tend to ignore the macro data as the base is still very small. We have seen the success of new consumer brands over the past 5-10 years including Paper Boat, Bira, Sula, Veeba, Raw, Epigamia, ID Fresh, Patanjali and Vini. Many of them have created Rs100 crore businesses in a relatively short time and have seen real value creation. The early investors have seen very good exits and returns, which has made the sector more closely tracked by the others in the market. But it is a very tough sector to crack.

Five years ago, there were a handful of early-stage venture capital funds looking at the non-tech consumer stage, including Saama, Sequoia, SAIF and DSG Consumer Partners. However, this is changing. Most investors are trend-followers and not trend-setters. They follow the herd. Today, most funds have a consumer strategy including many of the Indian and Silicon Valley funds. It is good to see recognition for the sector, but the consequence is valuation inflation where many seed and Series A deals are priced to perfection and do not appropriately price in the risk of such start-ups.

We are now being ultra-cautious with new investments and being disciplined about what we pay. Fortunately, there are enough entrepreneurs who see the value funds like us bring and look beyond the highest valuation. The last two deals we announced and the next one, which we will announce in a few weeks, had multiple term-sheets and the entrepreneur elected to work with us despite competing offers at a significant premium. While I expect to see many more consumer start-ups, I also expect to see many more failures as too many competing, me-too firms emerge, fight for the same shelf space and often compete on price. It is Darwin’s evolution. At DSG Consumer Partners, we expect 30% of our seed stage investments to fail and not raise Series A. This must be priced into the seed round. This is where we are seeing unrealistic expectations. Our seed rounds have been priced at $1-2 million pre-money over the past 5 years, but we are seeing this get towards $5 million, which is dangerous.

For challenger brands, who have one or a few successful products, how tough will it be to move up the value chain and expand their product offering and get customers attracted to a slew of products from that brand? How tough and costly will innovation become as they look towards the next stage of growth?

India is very early in the cycle. Most challenger or niche brands are in their first innings—so have one or a few successful products. Think about Paper Boat, Bira, Veeba, Raw and even Sula. You create, you launch and you establish yourself. This is very difficult. If you succeed, you make it to the second innings. Now is when you evolve from a niche play to a real challenger brand. You need to think about your assets, your strengths and how to leverage them. How do you maintain that challenger or niche position and grow your portfolio? This may mean new products, new geographies, new brands or a combination of the three. Let us take Sula wines. It launched in the market in 2000 as a niche brand. By 2004, it was a challenger brand against Indage, Grover and Four Seasons. Today, Sula is the market leader. What next? It has decided to leverage its strength in grape spirit to enter the spirits market with brandy and whisky under the Janus and Eclipse brands. Expect to see more of this from the top decile of successful next-generation brands… Innovation is not only about costs. There are many levels of innovation—product, business model, packaging and more. Each of them will innovate at their own level and it will be a function of what is happening in their sector and their competitors. It is not as costly as you may think. As these companies scale, their ambitions will become bigger and so will the cost of entering and playing in each market. The upside is huge and there is a lot to play for. You will see many of these next-generation companies get sold for over Rs1,000-4,000 crore.