Constraints to scale manufacturing in India - the entrepreneurship deficit?

I blogged here about the state of India's footwear industry.

As western and Japanese businesses seek to exit China and active efforts are underway to recalibrate the global manufacturing value chains, discussion invariably involves India. 

Given the size of the market, it is surprising that India struggles with scale manufacturing. Even neighbouring Bangladesh, for example, has much bigger textiles manufacturing facilities than India. The country's marginal role in the global contract manufacturing market is surprising.

The conventional wisdom on the deficient scale of Indian manufacturing blames poor quality of infrastructure, restrictive labour laws, difficulty in assembling large land parcels, high cost of capital, and pervasive red tape. These are all, in general, legitimate areas of concern. But even where these are taken into account (like with SEZs and already existing large manufacturers), scaling has proven elusive.

Labour management including labour relations are critical factors even if other issues are addressed. All discussions about labour issues tend to focus on problems with retrenching workers and compliances. For sure, when lay-offs are difficult, labour hiring becomes almost like a fixed investment. This is important since manufacturing for the export market exposes the company to the business cycle risks, which demands retaining the ability to scale down production and lay-off workers. 

But an equally important factor when dealing with facilities employing thousands of people is the sheer human resource challenge of managing them, distinct from the labour laws themselves. Managing a facility with 15000 workers is qualitatively different than managing one with 3000 workers. While there are many large employers in India, they are generally spread over several production facilities. The recurrent issues and problems with labour issues can take up significant senior management bandwidth, besides the attendant risks and tensions.

This brings us to an important overlooked dimension, the innate characteristics of these entrepreneurs. In particular, the deficiency of entrepreneurial ambition and risk appetite to scale, among the small universe of those who are well-positioned to scale. This is applicable to entrepreneurs across sectors. While I have not come across studies in this regard, anecdotal evidence from multiple sources point in this direction.

This is important also since scale manufacturing also comes with embracing a much higher level of risk, an appetite which Indian companies outside of a tiny handful for very large groups involved in infrastructure sector have not exhibited. For example, large contract manufacturers are exposed to the vagaries of the business cycle and associated risks of cash-flow management, demanding customers which in turn necessitates constant technological upgradation, and so on. All these require an entrepreneurial spirit and risk appetite that is qualitatively different from that of being a successful mid-sized manufacturer. The example of Reliance may be an outlier in terms of ambition and risk appetite, but conveys the mindset required. 

The entrepreneurs of firms in the INR 100-200 million revenue category, located in Tier II and III cities, earn more than enough to have very comfortable lives. They earn enough to afford a BMW car, an annual European holiday, and send their children abroad for studies. This satisfaction and lack of risk appetite is an under-appreciated constraint on scaling.

Then there is the dynamics of family-owned businesses. The smaller size of the enterprise also helps them control their business without relying on outsiders and professional managers. It also limits the commercial risk exposure from a business downturn. They can rely on some local and loyal staff to manage the business. Scaling also requires capital investment in greater automation and adherence to higher standards. All this adds layers of costs and there is the danger of losing control and assumption of greater business risks.

At a conceptual level, this is not to completely discount the value of family businesses. In fact, today, with listed businesses more focused on short-term results and stock market performance based on leverage-financed stock buybacks, there is a strong argument that virtuous and conservative businesses are a strength to the economy. It is just that an excess of everything, including conservative business practices, can be sub-optimal. 

In fact, these forces are likely to be even more relevant in case of the larger firms. They would have to take the leap of faith of entrusting critical operations to professional managers, with all the attendant risks of delegating power and losing control, not to mention costs. More importantly, expansion also necessitates going beyond bank finance and attracting either external capital from the public or private markets. This entails sharing control over the business decisions. Besides, it also involves greater adherence to certain standards and practices, which increases external oversight and reduces operational flexibility. 

Typically, from among the universe of growth-focused small manufacturers a few grow into medium-sized ones,  fewer still to large ones, and a minuscule proportion into very large ones. But what if the universe of ambitious enterprises from which the very large manufacturers emerge is itself so narrow as to seriously limit the prospects of progression?

In fact, apart from the occasional start-ups, the expansion that happens in the industry comes more often when a family business is divided and siblings spin-off their own independent businesses. This is often described as the “divide and grow” feature of Indian family owned businesses. This stands in contrast to the “conquer and grow” approach that is the essence of scaling. 

Another requirement for scale manufacturing is the availability of component manufacturers and product development facilities. Large manufacturing is about creating eco-systems that can help lower transaction costs and leverage efficiencies and economies associated with scale. Establishing a large manufacturing facility is about transplanting an eco-system. It is for this reason that large  footwear contract manufacturers that have relocated to India like Lotus and Apache have brought along with them their component suppliers and they too are located within their large integrated facilities.

Update 1 (24.07.2020)

Is Adar Poonawala, the CEO of Serum Institute, an exception to the norm?

Poonawalla, who was already working with the University of Oxford on a malaria vaccine candidate, was quick to spot the promise of its Covid-19 vaccine (code named AZD1222). Serum Institute now has a tie up with AstraZeneca-backed Oxford vaccine candidate for one billion doses which it will make for India and the GAVI vaccine alliance of 58 countries. Poonawalla is perhaps the only Indian vaccine maker who has decided to start making a vaccine (which is still under clinical trials) on “personal risk”. He has said in his recent interviews that Serum Institute is putting in $200 million to create capacities for the AstraZeneca-Oxford vaccine... in around 2005-06... Serum Institute was supplying vaccines to around 35 countries... He got the Serum Institute vaccines validated globally and began supplying to aid agencies including the World Health Organisation (WHO). Today, Serum Institute exports to around 150 countries across the world, sells over 1.5 billion doses of vaccines and is the world’s largest vaccine maker in terms of volumes.