The missing dynamism and scale in private sector - the case of corporate India

Why has India struggled to realise its latent economic potential? The typical answers largely blame political system and bureaucracy. It is surprising that an almost equal contributor to the problem, corporate India, escapes even a mention. 

For a country of India's size and its several baseline advantages at independence compared to its peers, despite all the acute challenges of political and bureaucratic deficiencies, infrastructure bottlenecks, and capital constraints, its corporate sector performance should count as deeply disappointing. Even by the standards of its emerging market peers, India's private sector's performance has been poor across several dimensions.

The objective of the post is not to apportion blame, but to draw attention to this important and hardly mentioned fact about the Indian economy.

I have blogged here, here, and here highlighting corporate India's persistent failures to produce world class entprereneurship, create global brands, and innovate and expand technology frontiers. I have blogged here, here, here, and here about the failure of the country's startup eco-system to generate innovators and innovations which have had a significant impact on the country's development or push the frontiers of innovation. I have also blogged here and here about India's deficit of high quality entrepreneurship which leads to scale, this and this about its persistent corporate governance problems, this about how while market participants game the regulations bureaucracy responds with more regulations. I also blogged here that even Indian capitalists appear to avoid making risk capital investments in India. 

Beyond copycat entrepreneurship, India's much hyped start-up eco-system has struggled to produce anything of note either in areas of cutting-edge technology or in addressing critical challenges to national development goals. India's IT sector, despite being well-placed at the beginning of the IT boom, has failed to produce any major business or consumer products. Corporate India, despite the presence of established companies at the time of independence, has failed to produce any major global consumer brand. 

A complementary manifestation of the private sector weakness is the trend of business concentration across sectors, which has been more marked in India than even in the US.

In a recent oped Akash Prakash pointed to an Ambit Capital study which showed that Indian companies are small than even by emerging market standards,

She has looked at 2,865 (ex-banking, financial services and insurance or BFSI) listed companies and found that approximately 40 per cent had revenues less than Rs 100 crore. Surprisingly, despite the growth in the economy, this ratio has not changed at all in the past decade. The share of small companies is not declining. In all, 55 per cent of our listed companies had revenues between Rs 100 crore and Rs 10,000 crore and less than 4 per cent of our companies had revenues greater than Rs 10,000 crore. We have only 12 companies (ex-BFSI) with revenues greater than Rs 1 trillion. The story is similar for the BFSI universe as well. Too many midget firms, not enough global scale companies. Even in the unlisted space, despite limited data, the average size of companies is even smaller. When one compares India to other large EM countries, the disparity is stark. While we have 40 per cent of our companies with revenues less than Rs 100 crore, the median among large EM countries is 12 per cent of their companies. Fifty five per cent of our companies have revenues between Rs 100 crore and Rs 10,000 crore, but the EM median is 64 per cent. Less than 4 per cent of our companies have revenues greater than Rs 10,000 crore, whereas the EM median is 15 per cent. Clearly, our corporate sector is skewed towards smaller companies than our peers...  

Just look at the 12 companies with revenues over Rs 1 trillion. They are all either public sector units (PSUs) in the energy space, or firms like Tata Steel and Tata Motors, which have acquired their way to global scale, or multi-product conglomerates like Reliance Industries Ltd and Mahindra Group. The only exception is Tata Consultancy Services, which has acquired global leadership in a sector. There are few companies with scale, focused domestically on one single industry.

This is echoed by a recent report by the consultant McKinsey, which had this sobering assessment about India's large firm (annual revenues greater than $500 million) universe,

India has about 600 such firms. Their labour productivity is 11 times higher than that of the overall economy. They are 2.3 times more productive than midsize firms (revenues between $40 million and $500 million), and their profitability is 1.2 times greater. They account for almost 40 percent of total exports and employ 20 percent of the direct formal workforce. They provide jobs with better benefits than other companies do... Large Indian firms contributed revenues equivalent to 48 percent of nominal GDP in 2018. Large firms on average contribute 1.5 to 1.6 times more in other outperforming emerging economies, including China, Malaysia, Thailand, and Vietnam—and 3.5 times more in South Korea.

This pattern holds in a number of key sectors. For example, the revenue contribution of India’s 27 large construction firms is 11 percent of the sector’s nominal gross value added (GVA). Other outperformer economies have between two and ten times the number of large firms (adjusted for size), and their revenue contribution is roughly seven to 12 times larger. The story is similar in retail trade, where India’s 48 large firms make a revenue contribution of 38 percent of nominal GVA. Adjusted for size, that is about one-half to one-quarter the number of large firms in peer economies, whose revenue contribution is up to 13 times larger. India’s large firms have also not achieved their productivity or profitability potential. Overall productivity levels are on average one-tenth to one-quarter those of peers in other outperformer economies across sectors... The profitability of India’s large firms, measured as return on assets, has been falling since 2012, from 1.9 to 1.2 percent, particularly driven by a few sectors such as financial services and construction, among others. Profits are also concentrated within a few large firms. Our analysis shows that just 20 of the country’s roughly 600 large firms contribute 80 percent of the total profit of large firms...

India has a “missing middle” of midsize firms that typically grow into formidable competitors of larger rivals and, as happens in other emerging economies, eventually topple some of them from their perch. For example, peer emerging economies have almost twice as many midsize firms per trillion dollars of GDP with revenue between $40 million and $500 million. As a result, peer economies end up with 1.6 times the number of large firms with revenues more than $500 million, compared to India, per $1 trillion of GDP. The upward mobility of small and midsize firms matters because it influences the degree of competitive pressure to which large firms are subjected. The higher such pressure, or contestability, the greater the likelihood that only the most efficient and high-performing firms will survive at the top. In some other emerging economies, it is harder for big firms to stay at the top... In order to achieve higher and system-wide productivity, India would need to raise the level of contestability and enable 1,000 or more small or midsize firms to scale up to large firms, and 10,000 or more small firms to scale up to midsize

Small size is complemented with low R&D spending by even the largest firms. Sample this from 2017 on corporate India's R&D spending,

Huawei’s R&D expenditure (around $6.5 billion) is about the same or more than that of Indian industry, while Microsoft spends (around $12 billion) about the same as the Indian government.

The R&D spending of even the largest corporates like Reliance and the software majors is a tiny portion of their total income. 

In this context, the point about the much smaller than hyped size of the Indian market is also important. After all, the strength of the private sector is also related to the demand for their produce. A recent news reported that Toyota has decided not to expand its India operations. It follows Ford and GM exiting independent production in India, leaving local manufacturing confined to the compact car makers like Maruti Suzuki and Hyundai. One of the reasons being high taxes on vehicles making ownership prohibitive,

In India, motor vehicles including cars, two-wheelers and sports utility vehicles (although not electric vehicles), attract taxes as high as 28%. On top of that there can be additional levies, ranging from 1% to as much as 22%, based on a car’s type, length or engine size. The tax on a four-meter long SUV with an engine capacity of more than 1500 cc works out to be as high as 50%.

It is hard to believe that this alone is the reason for such a big decision. However, that's beside the point. Even with the high taxes, given the country's population and low base of vehicle ownership, and absence of alternative lower cost vehicles, demand should never have been a problem for vehicle manufacturers, at least for several more years. This also points to the issue of India's far smaller market than estimated, a fact that we've highlighted in Can India Grow?. In fact, the Toyota India Vice Chairman points exactly to this,

India needs to have demand for a product before asking firms to set up shop, yet “at the slightest sign of a product doing well, they slap it with a higher and higher tax rate.”

Andy Mukherjee makes the point nicely,

India must break out of this vicious cycle in which taxes are high, consumer demand is low, investment and job creation are constrained, and wage incomes are insufficient to boost purchasing power at the bottom of the pyramid. Taxes are hence exorbitant and have to be collected from a small consuming class that can afford a $23,000 Toyota sedan — and fill it up with highly taxed gasoline that costs three-quarters more than what Americans pay. 

Both these also highlights the capital accumulation challenge facing the Indian economy. India does not possess the capital foundations to sustain high growth rates for long periods, and needs to accumulate capital on multiple dimensions - financial, physical, human resource, and institutional. And corporate sector, which has been sorely deficient till date, needs to step up to play its role.