Staking Startups

A look at funding sources driving rapid, sometimes unanticipated innovation and entrepreneurship in emerging markets

In their new book, Financing Entrepreneurship and Innovation in Emerging Markets (Elsevier, 2018), co-authors Lourdes Casanova, Peter Cornelius, and Soumitra Dutta shed light on the role startups play in innovation and economic development in emerging economies, and they attempt to isolate common conditions across geographies that enable entrepreneurship to thrive. Access to finance is particularly critical, according to their research, and innovation, economic growth, and financial development are inextricably intertwined.

For developing countries, innovation is key to creating a thriving economy. “Sustained economic growth can be achieved only if there’s permanent innovation. It’s required for productivity growth, and productivity growth is needed to achieve sustained economic growth,” says Cornelius, managing director at AlpInvest Partners and a research fellow at Cornell’s Emerging Markets Institute. “However, innovation and creative destruction isn’t possible without adequate funding.”

To distill and illustrate lessons from emerging innovation leaders like China and India, the authors treat them not only as country-level case studies, but also devote chapters to Chinese and Indian powerhouse firms Tencent and Flipkart. As these companies form Google-like innovation ecosystems, they (and others like them) begin to cross borders and become global changemakers, accelerating innovation, job creation, and economic development at home and abroad.

Importantly, “both companies were initially backed by venture capital, a form of financing that is gaining significant momentum in China and India and in several other emerging markets,” notes Casanova, director of the Emerging Markets Institute in the Cornell SC Johnson College of Business. Adds Cornelius: “Furthermore, both Tencent and Flipkart have become major providers of venture capital themselves, backing a significant number of entrepreneurial firms that have emerged as unicorns — startups valued at $1 billion or more.” In fact, in their study the authors list 83 unicorns in China and India, accounting for nearly one-third of all unicorns worldwide.

A key point of the book is that change is happening rapidly and in unanticipated ways; consequently, traditional innovation measures often don’t apply. So economists must adapt and develop new innovation measures applicable to emerging economies. “Lots of traditional innovation measures were around patents, PhDs, and research citations — very traditional science and technology indicators,” says Dutta, professor of management at Johnson. “In emerging markets, these aren’t fully captured, since a lot of innovation comes from farmers innovating though mobile technology or young kids innovating with mobile apps.”

“In emerging markets, a lot of innovation comes from farmers innovating though mobile technology or young kids innovating with mobile apps.” — Soumitra Dutta

By augmenting traditional innovation metrics (like number of patent applications) with new indicators (like the ease of paying taxes), the Global Innovation Index, an annual publication that Dutta co-edits and which he developed while he was a professor at INSEAD, considers a much more holistic set of inputs and outputs to judge country-specific innovation levels. “Much more is happening than one would expect — more in seed money, more in VC money. That’s new and has not been looked at before,” he says.

Chinese companies Baidu, Alibaba, and Tencent, for example, have grown to become comparable in size to U.S. tech juggernauts like Google, Facebook, and Amazon, write the authors. And their level of innovation now rivals those firms in some instances.

Take mobile payments, which have experienced relatively slow acceptance in the United States compared with some emerging markets, like China. Mobile payment functionality was built into applications like Tencent’s mobile messaging app WeChat and the world’s fastest-growing e-commerce platform, Alibaba, at a much earlier stage. “[Facebook CEO] Mark Zuckerberg now travels to China to see how Facebook can most effectively incorporate WeChat’s features,” particularly around mobile payments, says Casanova. “That would have been unthinkable even five years ago,” she says.

“Mark Zuckerberg now travels to China to see how Facebook can most effectively incorporate WeChat’s features. That would have been unthinkable even five years ago.” — Lourdes Casanova

But how can other countries re-create China’s level of innovation, where the government prioritizes economic growth in a framework that is highly idiosyncratic? Rather than try to re-create what works in Silicon Valley or Shenzhen, for instance, “innovation policies and institutions need to be context-specific and reflect the heterogeneity and varying trajectories of countries,” write the authors.

If country-level policies must be designed for local context, the same can hold true for individual firms. Entrepreneurs in the developing world that adapt to local conditions, rather than copying big U.S. firms, can make a huge impact, write the authors. For instance, in Kenya and Tanzania, M-Pesa’s mobile payment and microcredit models have sparked widespread grassroots innovation. Similarly, Nigerian e-commerce company Jumia pioneered the hugely successful payment-on-delivery model. These examples illustrate how mobile technology, in particular, has enabled innovations adapted to developing markets to gain widespread adoption.

Of the 81 total indicators measured in the Global Innovation Index, human capital investment and institutions are the top areas in which emerging markets most significantly lag behind their developed counterparts, Dutta says. That’s why the authors devote several chapters to examining how government programs, educational systems, and business incubators can turbocharge innovation in emerging economies when paired with a variety of funding options. Without these, a simple fact remains: “Unless more entrepreneurial startups in emerging economies find funding beyond friends and family, a lot of great ideas will not materialize,” says Cornelius.

“Unless more entrepreneurial startups in emerging economies find funding beyond friends and family, a lot of great ideas will not materialize.” — Peter Cornelius

While bank loans appear to be the natural choice for startups without collateral and earnings, it is usually very difficult to access this source. This is true in advanced economies like the United States, but it is even harder in emerging economies, where banking systems tend to be less developed. Luckily, as the authors show, new forms of funding are emerging. Apart from venture capital, the book focuses especially on angel investing, corporate ventures, crowdfunding, microcredit, and emerging fintech approaches. While these sources are still embryonic, Casanova emphasizes the substantial potential they might have: “In China, for instance, business crowd-lending totaled less than $1.5 billion in 2013. Two years later, the volume already exceeded $40 billion.”

While the authors acknowledge that most emerging economies are years from consistently competing with the world’s leading innovators, Dutta says western businesspeople would be wise to sit up and take notice now. “My major point is not to look at innovation in emerging markets as an isolated phenomenon but something that affects developed markets,” says Dutta. With that in mind, Financing Entrepreneurship and Innovation in Emerging Markets serves as both a primer for policymakers in the developing world as well as a guide to navigating the disruptive innovation just beginning to migrate from emerging markets to the developed world.