The republic’s young, 264 million-strong population and burgeoning internet economy make it a behemoth in the region. Yet, it is hampered by a highly complex regulatory landscape and a massive, fragmented domestic market. In the third of our series on Southeast Asia, we take a look at Indonesia’s challenges and opportunities.
SINGAPORE (Oct 14): Indonesia now has five unicorns, the moniker given to start-ups valued at more than US$1 billion ($1.4 billion). OVO, the digital payments service unit under Lippo Group, has joined the ranks of Gojek, Tokopedia, Traveloka and Bukalapak, apparently fulfilling a government target, according to Indonesia’s Communications and Information Minister Rudiantara, who disclosed it on national media Antara on Oct 5.
Indeed, Indonesia is set to account for the bulk of the total internet economy of Southeast Asia, according to a recent report titled “e-Conomy Southeast Asia 2019” by Google, Temasek and Bain & Co. The report’s authors estimated that the Indonesian internet economy will reach a whopping US$130 billion in gross merchandise value by 2025, with an average growth rate of 49% since 2015. That is more than one-third of the estimated US$300 billion GMV of the internet economy in Southeast Asia, making Indonesia a giant in its own right within the region. Certainly, investment money is pouring in — the same report showed that funding into the economy in Indonesia stood at US$1.8 billion invested in 1H2019 alone.
Across the 742,308 square miles that make up the sprawling Indonesian archipelago, large deals are being made — not in boardrooms, but in glitzy, modern tech offices and co-working spaces. Large funding rounds have been completed by the likes of Bukalapak, Gojek, Tokopedia and Traveloka. Singapore-based Grab has also announced a multibillion-dollar commitment to invest in the country over the next few years.
Indonesia is looking at tremendous growth in its digital economy for the foreseeable future, backed by its 152 million active internet users who are connected to the mobile internet for approximately four hours a day, compared with the global average of three hours and 13 minutes.
Indonesia is also the largest, and one of the faster-growing, economies, with a GDP of US$1.042 trillion. The World Bank predicts GDP growth of 5.3% in 2020. The country’s GDP per capita has steadily risen too, from $823 in 2000 to $3,932 in 2018. Its 264 million population of some 300 ethnicities are spread across an archipelago of more than 17,000 islands, making it the world’s fourth most populous nation, and 10th largest economy in terms of purchasing power parity. The World Bank also expects Indonesia’s economic outlook to be positive, driven by domestic demand, robust investment, stable inflation, and a strong job market.
Yet, it is still struggling to overcome numerous challenges in parts of its “real world” economy. Despite the positive outlook, the country does not seem to have seized opportunities thrown up by the US-China trade war, unlike some of its neighbours. Significant trade and manufacturing has been diverted to Vietnam, for instance.
Furthermore, in 2019, Indonesia slid a notch to rank 73rd in the World Bank’s Ease of Doing Business Index. The rather dismal performance fell far short of President Joko Widodo (Jokowi)’s expectations that the country would rise to as high as 40th place.
“Fortunately or unfortunately, Indonesia is not really well connected to the Southeast Asian supply chain, which is why it did not feel the full impact of the trade war,” says Masyita Crystallin, an economist at DBS Group Research. “But it also did not see the filtering-down of trade and the shifting of production from China, unlike Vietnam or Taiwan. I haven’t seen a specific industry here [benefitting] from this trade diversion, although the government is trying very hard to get [the trade].”
In addition, technology is turning out to be both an enabler and a barrier to Indonesia’s growth. On the one hand, its highly connected population, with mobile phone penetration of close to 50% in urban areas, is driving growth and opportunity in the internet economy. On the other hand, the challenge is in monetising and increasing profit margins for the players in Indonesia’s digital economy.
Indeed, for that to happen, pundits say, Jokowi’s government will have to resolve several fundamental issues — a highly decentralised, fragmented system of governance, rising inequality and, even with spanking-new rail systems and roads, considerable challenges with infrastructure.
Challenges for Indonesia
Florian Hoppe, partner at Bain & Co and leader of its Digital Practice in Asia-Pacific, tells The Edge Singapore that even with the rapid growth of the internet economy in Indonesia, the fundamental logistics and payments infrastructure is still not quite in place, although it has improved greatly in the urban areas with the rise of mobile wallets.
Right now, Hoppe believes the digital economy profit margins are “not that great”, owing to a hugely competitive market, where much of the digital economy is in the investment stage.
Hoppe says some verticals — the segments of the internet economy, such as e-commerce, ride-hailing and digital financial services — have yet to switch on the “monetisation engine”. Revenues have increased, but so have costs, leading to smaller margins and even losses. “Some verticals are starting to be profitable, but a number of them are still heavy in the investment stage, in particular e-commerce, food delivery, ride-hailing and digital financial services,” he says.
A major hurdle to any concerted regulatory and infrastructure improvement is Indonesia’s decentralised power system. The system — put in place nearly 20 years ago by Bacharuddin Jusuf Habibie, the successor of Indonesia’s iron-fisted dictator, Suharto — grants varying levels of legislative autonomy to the various provinces, regencies, cities, districts and administrative villages. Five of 34 provinces — Aceh, Jakarta, Yogyakarta, Papua and West Papua — have greater legislative independence from the central government than others, essentially having the right to their own legal system, in some areas.
It was aimed at giving greater authority, political power and financial resources directly to the local governments, eliminating a one-size-fits-all method of ruling by a centralised government. The idea was to let local governments run their localities as they see fit, and essentially encourage more efficient use of resources and funds. It was also supposed to deter the return of a strongman like Suharto. Decentralisation has proved, however, to be both a boon and a bane.
“How to start a business and licensing [in Indonesia] are challenging in the first place, and it’s even more challenging with decentralisation and all these independent, yet unsynchronised, regulations in place,” says DBS’s Masyita. An investor or business owner looking to enter Indonesia has to tackle different regulations, depending on which province it intends to set up in.
Jakarta-based Masyita says the central government has tried to improve the situation by launching the online single submission (OSS) licensing system. But implementation has proved patchy, at best. For starters, the website runs only in Indonesian, at least for now.
“But we’ll see, because it is something that is prioritised by the government,” Masyita says. “Having domestic contacts to understand the local context and hiccups will probably be beneficial for investors.”
Khairul Anwar, regional group director (Indonesia) at Enterprise Singapore, echoes Masyita’s recommendation. “The regulatory structure in Indonesia can be complicated, as there are both central and regional governments, so the structures for business regulations will be different from those in Singapore. Thus, companies should be patient and bear in mind the time taken for business registration and approval.”
He also points out that competition is fierce in Indonesia. “Because of its huge consumer base and favourable demographics, the Indonesian market is attractive to many foreign investors. Many MNCs and foreign companies entered Indonesia in the past few years, resulting in a competitive consumer sector as brands fight to stand out,” he says.
Inequality and imbalance
Another pressing problem for Indonesia, according to ISEAS-Yusof Ishak Institute’s Indonesia Studies programme co-coordinator Siwage Dharma Negara, is inequality and an imbalance — in the development of the more rural provinces of Indonesia and economic opportunity.
The West Papua region, for instance, remains the poorest region in Indonesia, despite being one of the most resource-rich. The world’s largest goldmine, the Grasberg mine, is located in West Papua and co-owned by US-based Freeport-McMoRan through its Indonesia subsidiary Freeport Indonesia and the Indonesian government.
In August, violent protests erupted in the area after a group of students claimed mistreatment and racial abuse from the police, as a result of clashes at a pro-independence rally the students had held. The region is a former Dutch colony incorporated into Indonesia after a widely criticised and controversial UN-backed referendum in 1969; pro-independence movements have long been going on there.
“There are social implications and unhappiness in the local community with regard to the [mining activities]. They think that all the development in their region benefits only a small group of investors in Jakarta, and not them,” Siwage explains. “What happened in Papua is actually only a small [part of the bigger] picture of what has been happening because of the imbalance of development in Indonesia.”
Siwage says economic opportunity is limited for those in the provinces outside Jakarta and, indeed, even for people living on the island of Java itself. “It is much easier to get jobs that pay more in cities like Jakarta, Surabaya and Bandung,” he says. “A lot of young talent from different parts of Indonesia move to the big cities in Java to get better jobs and career promotions. So, what happens is, in the other regions, they suffer brain drain and have a lack of a talent pool.”
As a result, this widens the imbalance; investors both foreign and local come into the other regions to tap the rich natural resources, find it hard to get manpower or skilled talent, and end up hiring foreign workers. Ultimately, there is little knowledge transfer or trickle-down economic benefits to the local communities, he says.
The challenge for the country, Siwage says, is to balance between the need for foreign investment and the interests of its large domestic economy. Moreover, Indonesia has to break through to become an advanced economy, building more high-skilled, high-complexity and technologically advanced industries.
“Take the automotive industry, for example. There was talk of a national car for Indonesia, like in Malaysia, but right now the industry is still very much on assembly, not R&D. There is not much upgrading of value or going up the value chain. There is not enough technology transfer within the industry,” he says. “The government wants to encourage more investors to bring their R&D units into the country to develop this capability in the country; it knows technology transfer is critical for the country. The problem is whether Indonesia can offer enough incentives to the foreign investors to bring their R&D into the country.”
Plenty of potential
Despite the challenges, experts still agree Indonesia is flush with potential. This progress is being supported by regulatory and infrastructure improvements, a willingness to trade and a growing talent pool. In fact, Singaporeans stand to benefit greatly from investing in Indonesia, and have done so — Singapore is Indonesia’s largest foreign investor, with investments of US$3.4 billion comprising 5,348 projects as at 1H2019.
Enterprise SG’s Khairul says there is a lot of potential in sectors such as consumer retail, manufacturing, digital and start-ups, and infrastructure.
“Indonesia’s favourable demographics and huge consumer base are expected to drive opportunities in the consumer sector, and this will create demand for better quality and variety of products and services,” he says. “This presents opportunities for Singapore companies in consumer-related areas, from food and retail, to education, wellness and leisure services.”
He also believes that manufacturing will continue to be a key pillar of Indonesia’s economy, accounting for 19.8% of GDP. In fact, the Indonesian Ministry of Industry launched its Industry 4.0 Roadmap in April 2018, which aims to boost the industry’s competitiveness by incorporating major innovations, showing a drive to boost production.
In terms of the digital economy, Khairul says the sheer size of Indonesia’s digital economy shows strong growth potential in e-commerce and services such as logistics and fulfilment, and fintech. Finally, infrastructure is likely to continue as the focus of the Jokowi administration. “The key sub-sectors of focus, we see, are energy, water and connectivity. There is also an increasing need for real estate in tandem with the growth of the middle class in Indonesia. This opens up opportunities for our players,” he adds.
ISEAS’ Siwage says there is no complacency when it comes to attracting foreign direct investment, despite Indonesia’s strong domestic economy and consumption, which contributes 57% of its GDP.
“Indonesia understands the downward pressures from the external conditions. It realises that it is not as easy to reach the high growth targets as it was in the past, and that depending on domestic consumption alone is not helping to boost growth,” he says. “I think policymakers understand, and they [will] keep pushing for foreign investment, and I do see that Indonesia is trying hard to compete to attract more investment.”
Benjamin Twoon, co-founder and chief operating officer of Fundnel, a Singapore-born, Jakarta-based private investment platform that uses artificial intelligence to curate investment opportunities, points to the strong backing that Indonesian companies have attracted. “Just look at the potential decacorns [tech companies valued at above US$10 billion] in Indonesia,” he says. “Some of the most valuable companies in Southeast Asia are from Indonesia.”
Indeed, the Indonesian E-Commerce Association projects that the country will have two decacorns by year-end, highlighting ride-hailing company Gojek and e-commerce platform Tokopedia. Gojek is, in fact, one of Indonesia’s great tech success stories, having been valued at US$10 billion just this year, and recording US$9 billion in annual transactions in 2018 from all its business segments, according to confidential documents obtained by a tech news portal.
“The vibrancy of Indonesia’s start-up ecosystem has attracted global attention, and capital inflow is steadily rising. It is incredibly laudable how the country has produced four unicorns so far,” says Twoon. “This, in turn, paves the way for the country to sharpen its skill sets, particularly high-quality technology skills, to keep the momentum going. This is an area that President Joko Widodo has pledged to boost, which bodes well for our growth trajectory.”
Twoon cautions, however, that no business should enter Indonesia’s massive market without knowing its uniquely local wants and needs. “You can’t just have a great product, and replicate your experience running a foreign business here. You also need patience; it took us two to three years to connect with the ecosystem here.”
He says things move fast, overall, but some things — like regulations — do not. “You need a game plan to stay in the game, to stay relevant and create value while acting within boundaries set by regulations.”
Jeffrey Yuwono, co-founder and CEO of Sorabel, a women’s fashion e-commerce site, says Indonesia’s consumer is changing rapidly. “Indonesia has a population of more than 260 million, of which 90 million are making the transition from a subsistence lifestyle to a consumption lifestyle [according to a study by McKinsey]. This means eating better, travelling and buying fashion instead of clothes,” he says, adding that Sorabel’s GMV has grown eight times over the last four years, with more than 10 million downloads of its mobile app.
Nevertheless, even with the huge potential in Indonesia, Singaporean companies need to step up their game if they intend to expand into or enter the market.
Singaporean companies would be wrong to assume that Indonesian companies are likely to be a step behind them, Enterprise SG’s Khairul says. “On the contrary, Indonesia has many professionally run corporates that have grown in scale over the years, and are now seeking world-class solutions for their internal systems [accounting, legal and data analytics] and projects. Many are exposed to products and solutions from leading companies,” he adds.
“[So,] Singapore companies need to think hard about how to differentiate themselves when engaging these potential partners and clients.”
