When things are going your way, most people start believing it will continue like that forever. This stands particularly true for tech startups that were high on the boom that came along with Covid–19 as public and private market valuations alike soared. Venture capital (VC) money was coming in droves and everything seemed to head north perpetually until it didn’t.

Cracks began to appear in those high-profile initial public offerings (IPO), inflation started getting out of control and the FBR after constant reassurances for months pulled a Reza Baqir. Investors, who until now were actively pushing up the market on unfettered optimism, suddenly realised that most of it wasn’t grounded in reality. Then the corrections came as major funds either adopted a wait-and-see approach or cut down late-stage valuations.

At this point, you’re probably wondering what am I even blabbering about? The point is that for the past couple of years, the Pakistani economy has been heading absolutely nowhere except for the brief recovery mirage we were shown in early 2021. It’s the usual suspects dragging us down: external account imbalance, and the resulting devaluation and inflation. But with an uptick in the technology sector, many are increasingly pinning their hopes that it could lead us out of this perpetual mess.

To be fair, it’s not unfounded either. The sector really seems to be coming of age, as evidenced by the increasing share of information and communication technology in services as they have registered a compound annual growth rate of over 38 per cent since the end of 2015-16. Add to that the boom in startup funding, which reached over $365 million in 2021, and seems well on track to breach that figure as Q12022 investment was recorded at $177m, as per numbers compiled by Data Darbar.

Many VC-backed startups are practically reduced to a fraction of their once selves when post-exit unit economics pressures, instead of growth, take centre stage

But amidst all this, sometimes we lose sight of how technology itself can be cyclical as is often the case. Turning back to the US for a moment, a Pitchbook report shows that both software and VC-backed IPOs beat the NASDAQ100 — which comprises tech heavyweights — during times of booms but lagged in periods of pullbacks and corrections.

Read: The rise of Pakistani tech

What does that tell us? That technology sector is correlated with macroeconomic performance — something of a sore point for Pakistan. Before the statistics 101 fraternity throws in “correlation is not causation”, let me just clarify I am not looking to do a causal analysis here. In very simple terms, tech might find it hard to escape the realities of our macro economy.

Sure, the export-oriented services companies might be more immune, but that doesn’t seem to be the case for startups serving the local market. The simple reason is that a large number of current players are claiming to solve mass problems — pitching their hackneyed 220 million population number — and have a strong consumer focus. That in turn is a function of purchasing power, which takes at max two rounds of devolution to be squeezed. We’ve seen that movie all too recently.

Think of the e-commerce or fintech startups catering to the consumer segment with their hip customer experience and premium service, temporarily helped by discounts from investors rather than any competitive advantage. Except for someday magically figuring out the unit economics with enough volumes, it’s better to plan an exit. But how does that scale come when an overwhelming majority of the people can’t really afford the services?

You can bring in a thousand digital wallets with a sleek interface but what good are they if people barely have money to put in? I mean there’s a reason why the consumer accounts at scheduled banks — already a relatively privileged group and representing no more than 20pc of the population — have an average amount of Rs165,229 with more than 7m of them having less than Rs5,000. Go a layer deeper into the branchless banking data and the mean balance will come out to be Rs832. Good luck making it float with that.

Of course, with VC-backed companies you don’t necessarily have to make money as long as there’s growth coming in to keep raising follow-on rounds at higher prices. But at some point, there needs to be an exit. In other countries, that comes through a combination of liquid capital markets, major business groups actively doing mergers and acquisitions and private equity’s dry powder. Unfortunately, we don’t have any of these ingredients.

Even in cases of exits — say through secondary offerings or listings abroad by a few exceptional companies — where investors make significant returns, the question of what lies afterwards is of prime importance. After all, we are familiar with how many a VC-backed startup was practically reduced to a fraction of their once self when post-exit unit economics pressures, instead of growth, took centre stage.

None of this is to discount the potential of the technology industry in the country but to highlight that in order to sustain, its growth has to be complemented by a stable macroeconomy and healthy activity in other sectors. That’s something the policymakers need to wrap their minds around.

Published in Dawn, The Business and Finance Weekly, April 4th, 2022

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