African markets don’t match VC expectations

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There is a disconnect between startup ambitions and market realities. The 10- or 20-yearold African VC thesis predicated on a growing, young, tech-savvy, middle class has yet to be proven, notes one investor:

“Earlier this year I was in the AVCA [African Private Equity and Venture Capital Association] meeting and one investor asked, “what thesis should we have for Africa, given everything that has happened?” You know the thesis: Africa has a huge population, young demography, rising middle class, etc. It’s the same thesis that was there over ten years ago. Have we unlocked any of them? No. So we know this is going to happen, but we have not unlocked whatever potential everyone has been talking about, over 10 years or 20 years ago, so why are we just fooling ourselves? Let us build to survive. When we get to the point where we are okay, then we will build for returns or for scale.”

As described by this investor, a fundamental premise underlying the argument for venture-backed opportunities in Africa is the growth of its middle class, as a proxy for large consumer markets. This segment is smaller, however, and holds less purchasing power than assumed. In a 2018 report, the Brooking Institute projected that more than half of African households would have discretionary income by 2020 and noted that consumer expenditure had grown by a compound annual rate of 3.9% between 2015 and 2019. Despite this, household spending trails incomes. Additionally, BMI Research’s dependency index shows that having dependents reduces economic power for African middle-class consumers. For example, the average Nigerian consumer might be responsible for up to eight people.

Along with having limited purchasing power, African consumers are utility- and pricesensitive. They primarily spend their limited incomes on products or services that add value (i.e., “painkillers”). Yet African consumers may still not pay for a service with a seemingly obvious value, such as a solar home system, if the value proposition isn’t compelling. Consumers also make purchasing decisions based on prioritizing cost over loyalty and ease of purchase (where making change isn’t required). As a result, startups’ products have to be affordable and accessible, despite limited access to consumer finance.

African consumers are also expensive to acquire (so there are high consumer acquisition costs) and difficult to retain, as indicated by the low lifetime value of the customer. These consumers are also difficult and costly to reach for a number or reasons, but access to far-reaching digitally enabled distribution networks figures prominently.

What contributes to this situation? First, consumers are rarely amenable to fully digital distribution methods, preferring “tech touch “approaches that create trust by embedding human interaction. For example, African e-commerce businesses were initially challenged to reconcile African human interaction-heavy shopping norms with shopping cart-oriented Western practices, which were digitized and used as a template for e-commerce.

Second, startups may overestimate the degree to which their customers may be digitally literate, particularly if they live in rural areas. They may also fail to account for resistance caused by the level of risk these consumers assume when trying new products, especially when they have experienced past disappointments. However, some founders still expect technology adoption to increase as they educate consumers and deliver value-adding solutions digitally.

Finally, because of how difficult and expensive it is to reach consumer markets, multinational corporations such as telecom companies and banks are more likely to have the capital to invest in building large, mass market distribution networks than startups do.

More generally, African markets are fragmented, comprising many markets instead of just one. This makes it more challenging to expand outside home markets, a challenge that will be discussed later in this report. As well, the lack of infrastructure makes it more expensive than expected to build African startups because of the costs associated with building distribution networks and supply chains.

An investor describes this dynamic: “I am talking about a situation where our lack of infrastructure, our infrastructure deficit, the failure of leadership over the last 50 years since independence, has created a situation where we don’t have an environment that allows you to scale effectively. We have what I call a diseconomy of scale, so when we need to go from two outlets, or whatever your business is, to 10, your unit economics are worse, because you need to hire more people. You actually have worse unit economics as you scale because it has become so expensive to check all that stuff and because we just don’t have the infrastructure in place.”

 

The text above is an excerpt from the new report “Chasing Outliers: Why Context Matters for Early-Stage Investing in Africa”. This document is an excellent way to see how VC firms are responding to the contextual differences in the African market.

Download the full document here.

 


 

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