India's footwear industry - a reality check

The leather and footwear industry are often discussed as sectors to focus for indigenisation and capturing the global export market. But what are the practical challenges to be surmounted? How realistic is this goal?

The importance of the footwear industry arises from the fact that it can easily absorb millions of workers with basic education and some skill development trainings. The investment requirements in the industry is far lower than in others. It is possible to generate 50-60 jobs with just INR 10 million of investment. But, as outlined in this post, there are daunting challenges to be overcome if this goal is to be realised.

Let's get some basics about the industry out of the way.

The footwear industry makes 2 billion pairs, of which 286 million pairs were exported last year. It employs 2-4 million people, the vast majority as informal and contract labour and/or hired through manpower agencies and at very low salaries in the range of Rs 6000-10000.

In terms of value addition, the major share of the 2 billion pairs are low-end hawai chappals. Further, a large majority are non-branded footwear. For a large market, there are very few Indian brands. Furthermore, the Indian manufactures are disproportionately focused on the lower-value men's footwear and less on those of women and children which fetch higher prices.

In terms of business size, there are hardly 10 manufacturers with revenues of more than INR 1 billion (100 Crores). Most of the formal manufacturers are in the INR 100-200 million, employing 50-70 people. 

The vast majority of footwear market is non-leather based. Poly urethane based materials offer leather-like appearance at a tenth of the price. Accordingly, over 90% of the global trade is in non-leather footwear.

The industry is largely concentrated in UP (Agra and Kanpur), Tamil Nadu (mainly Chennai), Kerala (Calicut), Haryana, and West Bengal.

As a summary, the current state of the Indian footwear industry is characterised by small scale, very low productivity, low automation, stagnant growth, and pervasive informality. 

The highest value market segment is the mainstream global branded manufacturing in non-leather footwear. But this is a segment that has proved elusive even to the Chinese manufacturers, especially in the global market. It may well be outside the reach of Indian manufacturers, unless some particular brand breaks out due to a combination of exceptional entrepreneurship and even more exceptional good fortune.

Another high value market segment is that of branded leather manufacturing and its contract manufacturing. However, the environmental standards demanded in the global export market is a big barrier. On top of these, the recent closure of tanneries may have irretrievably snuffed out any hopes with this market expansion.

The next best alternatives may be to increase their share of the Indian branded manufacturing segment and become large scale contract manufacturers for global brands. This is the playbook of the Chinese footwear industry.

Therefore, in terms of opportunities to scale and expand the local manufacturing capacity, there are perhaps only three pathways:

1. Scale-up contract manufacturing, mainly, but not only, aimed at exports. This is the Make in India for the world template. It involves attracting the global value chains from China and South East Asia. But this, in turn, also requires attracting a few very large (larger than any existing Indian manufacturer) contract manufacturers, who could bring in their own component manufacturing and design ecosystem.

It also requires that some of the current medium and large manufacturers aspire to become very large contract manufacturers. How many of them have the required entrepreneurial appetite to do so and what can be done to support them?

2. Development of local brands for the Indian market. Despite low per-capita consumption, India is the world's second largest footwear market. This also means that the potential for growth and the associated opportunity for local manufacturing is huge. Instead, cheap Chinese imports occupy a major share of the market.

Any strategy to increase local branded manufacturing to capture this market has to focus on Make for India (and not Make in India for the world). This does not mean skimping on quality, but competing with the imported manufacturers by gradually improving productivity. This can be done only by efficiency gains to cut costs - improving labour productivity, local component manufacturing, greater automation (not full automation, but enough to enhance labour productivity), and economies of scale.

3. Support component manufacturers. The starting point for any scale manufacturing is the presence of a large component manufacturing industry. Unfortunately, like with other sectors, most footwear components are imported from China. This is not just the case with soles and uppers. Even islets, insoles, and laces are imported from China. It is stunning that even buckles in belts are largely imported from China.

Even the large non-leather contract manufacturers like Apache and Lotus import uppers and soles from China, Indonesia and Vietnam and only stitch them together in India.

What can the government do to support these three objectives?

1. Address the low productivity problem by supporting demand-based trainings.

Given the abundance of cheap labour, limited automation, and the poor general quality of manufacturing, most manufacturers rely on semi-skilled labour. They start on the shop-floor with menial work and acquire some basic skills to become the assembly line worker (mainly stitching). These workers demand low pay, and while have high turnover can also be easily replaced. The productivity of these workers is very low, lower by orders of magnitude compared to the typical Chinese workers. Needless to say, most of them are migrant workers.

In order to train the workers, the manufacturers have to incur the cost of trainings as well as bear their salaries. They have no incentive to bear this cost, even if a couple of months trainings can suffice.

There are productivity spillovers from at least partially subsidising the cost incurred by businesses in trainings. An appropriately designed incentive-compatible and easily monitored training subsidy which is demand-based can therefore be useful. The trainings can be for a period of 2-3 months, arranged by the individual manufacturers themselves, and the subsidy reimbursed.

2. Support increase in productivity by encouraging greater use of machines. India is a labour surplus country and automation is clearly undesirable for the Indian footwear industry. But the alternative to automation is not complete manual manufacturing. A certain level of automation is not only useful but also necessary to sustain a minimum level of productivity required for growth.

Unfortunately, like with other equipment, India has limited manufacturing of the cutting and sewing machines and other equipment that are used in the industry. Most of these are imported from China.

While capital investment subsidies are in general not a very desirable thing, some form of fiscal incentives may be necessary to encourage the smaller and medium sized manufacturers to increase their level of automation. Though targeting and tailoring these subsidies will be challenging, the government could consider a subsidy that is linked to some performance, either exports or on higher productivity growth.

3. Support on designs. A critical ingredient of the manufacturing ecosystem are designers. The design eco-system is chronically deficient. While the typical median foreign designers command $1000-1500 per day, the local designers come at INR 20000-40000 per month. The quality is naturally inadequate.

The Government of India already has specialised institutions on footwear design and leather research. There is a need to have them play a much more proactive role in supporting with supply of trained and quality designers. There may also be a need for an arrangement to access good quality designers at a reasonable cost. An incentive compatible subsidy mechanism may be required here too. This should be complemented with colour and fashion forecasting support.

4. Encourage formalisation. The government of India's recent decision to expand the coverage of the 12% EPF reimbursement of the employee's contribution for three years to the footwear industry is a step in the right direction. While there are no reliable figures, anecdotal evidence points to a formalisation of some labour. However, anecdotal evidence also points to the employers largely absorbing this subsidy and not passing on any benefit to the workers (in terms of higher wages).

5. Support the emergence of component manufacturing. Some of the larger branded manufacturers will have to be encouraged to take the lead in this regard. While they could provide the market assurance, the government could offer some fiscal incentives and/or interest subvention subsidy.

These are some areas where meaningful action can help move the sector out of its current situation. It is acknowledged that their effective implementation can be very challenging. However, in the absence of some action in these directions, there is little hope for any improvement in the footwear industry. For sure, the industry will not collapse, but will meander along business as usual. There may even be the occasional mutant success. But there cannot be a sectoral exit out of the current low productivity and stagnation trap. 

Note that I have not suggested any of the typical fiscal incentives like tax cuts or higher import duties.  Over the years, there have been several such rounds of such tax cuts which have failed to yield any of the promised results. In fact, they have not even led to much success in scaling even among the larger manufacturers. Further, these are championed largely from the perspective of the biggest manufacturers, which in India's case is a tiny part of the universe. And in case of these firms, there are several reasons to believe that these tax structures are the binding constraint to their growth into very large manufacturers.

On the industry side, some of the large contract manufacturers could also strive to develop their own brands in the local market. Similarly, existing brands should strive to expand their market share. More importantly, as mentioned earlier, the very large manufacturers have an important role to play in catalysing the development of component manufacturing.

What constrains scale manufacturing in India?

The conventional wisdom in this regard 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, factors of concern. But even where these are taken into account (like with SEZs and already existing large manufacturers), scaling has proven elusive. Given the size of the market, it is surprising that India does not today have even one manufacturer with sales turnover of even half-a-billion dollars.

While these are all important, an important overlooked dimension concerns the innate characteristics of these entrepreneurs. One of the most important is the deficiency of entrepreneurial ambition to scale, among the small universe of those on the starting line to look at scaling. This is an observation confined not just to leather or footwear industry. The entrepreneurs of these firms in the INR 100-200 million category, located in Tier III and IV cities, earn more than enough to have very comfortable lives.

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 investments in greater automation and adherence to greater standards. All this adds layers of costs and there is the danger of losing control and assumption of greater business risks.

Further, 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 investments in greater automation and adherence to greater standards. All this adds layers of costs and there is the danger of losing control and assumption of greater business risks.

Typically, from among the universe of small manufacturers a few grow into medium-sized ones, even fewer to large ones, and a minuscule proportion into very large ones. But what if the universe of enterprises from which the very large manufacturers emerge is itself so infertile 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 splits and brothers spin-off their own independent businesses.

The impact of reforms like GST, while certainly beneficial in the long-run, may have ended up squeezing the vast majority of the small manufacturers. For a start, for these small manufacturers, the compliance costs in terms of hiring accountants and IT requirements are a non-trivial share of their profits. Then there is the structure of the GST tariffs - 18% for the components and 5% for the final product. This means that the manufacturers capital gets locked up as receivables for a long time. For small manufacturers, these costs are prohibitive.

This is a sobering tale. It is far from the mainstream narratives that point to one where governments need to get out of the way to let India's innate entrepreneurial energies to be unlocked. Never mind, as Joe Studwell has brilliantly described in the examples of North East Asia, this is a narrative which has never based on any evidence. It is important for the Government to play an important role if the footwear industry can move significantly forward. The market by itself is unlikely to have the incentives or the capacity to manage that.

The intention here was not to write a post advocating massive government intervention in putting the Indian footwear industry into a higher and more productive growth path. But then reality cannot be glossed over for long.

The challenge is then two fold. What are the most impactful and least distortionary levers for government engagement? Does the government have the capacity to engage effectively in this regard?