The problem of scale
There is room for consolidation in India, but we need to guard against concentration of power
Ritika Mankar Mukherjee, a consultant with Ambit Capital, has written an interesting report, Scouting for Giants, highlighting the lack of scale among Indian companies. She has looked at data across time and countries and observed that based on revenues, Indian companies are much smaller than their counterparts elsewhere. We have too many small companies and not enough large global size corporations.
Her analysis goes into a lot of detail and showcases some interesting data. According to her report, not many Indian companies are able to scale up and change orbit. Despite three decades of 7 per cent real GDP growth (13 per cent nominal GDP) and a GDP of $2.8 trillion, our companies by even emerging markets (EM) standards, forget global companies, are just too small and seemingly unable to get larger.
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 ~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 ~100 crore and ~10,000 crore and less than 4 per cent of our companies had revenues greater than ~10,000 crore. We have only 12 companies (EXBFSI) with revenues greater than ~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 ~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 ~100 crore and ~10,000 crore, but the EM median is 64 per cent. Less than 4 per cent of our companies have revenues greater than ~10,000 crore, whereas the EM median is 15 per cent. Clearly, our corporate sector is skewed towards smaller companies than our peers.
Why this tendency towards dwarfism (small and unable to get bigger)? Does it even matter? Why should we even care? Our policy bias has historically always been against size and scale. Pre-1991, we had the whole monopolies and restrictive trade practices commission (MRTPC) regulatory framework in place. Size was frowned upon, and we worried about concentration of economic power. After that, whether it be in labour laws, small scale industry reservations or indirect taxation, the laws have always favoured smaller companies and discouraged size. The sheer complexity and multitude of regulations have meant that scaling up has been difficult. Capital has been scarce. The judicial and regulatory environment has also not been stable, thus discouraging large scale capital investment. If you are not sure of the regulatory environment, you will not make large and lumpy investments, which are by definition required to scale and long-term in nature.
Our domestic market does not seem big enough today to support global scale, except for a handful of sectors. This will eventually change as incomes and consumption rise. The country is too diverse and lacks the discretionary income to allow global scale as end markets are too fragmented. Just look at the 12 companies with revenues over ~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.
Our companies also do not spend enough on research and development (R&D). This has been highlighted before. This is partly a chicken and egg problem, as lack of scale does not allow large R&D budgets, but lack of research budgets will not allow breakthrough innovation either.
We have not been able to plug into global supply chains. If we had been a part of the global smartphone supply chain, for example, many companies could have changed orbit. Just look at the electronics sector in Taiwan, built on the back of the Apple supply chain. Our lack of competitiveness is visible.
As for why all this matters, there is a clear link between productivity and scale. Larger firms have the resources to invest and the scale to adopt modern technology and management. If we remain with a stunted, small scale corporate sector, they will not be able to compete. Given the way technology is transforming industries, an inability to invest, modernise and adopt best practices will lead to a lack of competitiveness.
There are two counter-trends, which can change the narrative. One, is the vibrant start-up scene. India has the third largest start-up ecosystem in the world after the US and China. This is an area where the government has made a genuine effort to help and support. We have nearly 30 unicorns, and 2-3 decacorns. Most of these companies will list in the next 24 months. They are mostly technology-enabled business models, which should be able to scale rapidly as digital penetration and discretionary purchasing power continues to grow in India. Others are companies which have global business models, either Saas or analytics. Given the nature of these business models, network effects, increasing economies of scale and so on, they will increase scale much faster. Most of these companies are digital natives and have less reliance on physical infrastructure.
Given the rapid formalisation of the economy because of demonetisation and the introduction of the goods and services tax, one would expect the large Indian companies to gain share and scale up quickly. Much of the informal economy is in trouble. This process has got further accelerated, as post the non-performing asset (NPA) crisis, neither the financial system, nor leveraged Indian promoters have the risk appetite to invest. Risk aversion is rampant and capital is herding to only the largest and safest credits. Across sectors we are seeing the large players gain share, heralding consolidation. While consolidation will help the winners gain scale and size quickly and boost economic returns and profitability for shareholders, there is a downside. Given how weak corporate profitability and balance sheets are at present, and the risk aversion in the financial system, we are seeing the emergence of two-three very large conglomerates that seem to be gaining disproportionate share. We may not want to go from no scale to two-three conglomerates controlling vast chunks of Indian industry. This is something worth guarding against.
The Indian corporate sector has a scale problem. It affects productivity and R&D intensity. It will get corrected over time, but we need to be careful that we do not move to another extreme of being an overly concentrated economic power.