India’s economic landscape

A representation of the Lion Capital of Ashoka...

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The Economist‘s special report on India Inc. states that unlike in western economies, successful Indian firms are predominantly government owned or family owned businesses. The conglomerate is the business model of choice and this empire building is reflective of the 1900’s economic landscape of the US. An Infosys is an exception, rather than the norm.

All this might seem a recipe for disaster. In Korea and Japan closely held and widely spread firms became slothful. So far India Inc has been different: its big business houses compete and innovate fiercely. Their returns on capital are neither pathetic nor outrageous and most are prepared to invest billions of dollars in the risky capital projects that India needs so badly.

In the past decade Indian business has not been on a journey towards someone else’s economic model, whether Chinese, European or American. It has not been growing out of an immature phase, or shaking off a simpler way of doing things. Instead it seems to have established its own equilibrium—what might be called “capindialism”—in which profits are controlled not by institutional shareholders but mainly by the state, or by entrepreneurs and their descendants. Outside the state firms, the fiddly conglomerate is the favoured form of organisation.

The special report blames India’s soft state for being the reason firms choose to grow into conglomerate structures. It claims that ‘horizontal and vertical diversification’ of professionally managed firms is proof of this thesis.

Yet the best explanation is India’s soft state. Courts can take years to make their minds up, so contracts are hard to enforce. Infrastructure is often poor, supply chains tricky, red tape a hazard, and markets for people, materials and finished goods unreliable. Tarun Khanna and Krishna Palepu of Harvard Business School coined this idea in a 1997 paper. In these circumstances it makes sense to do things yourself.

Indian Buffet

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This cause and effect reasoning seems to be rather simplistic for the complicated Indian Thali . It ignores the unique role of the joint family in Indian society. It also ignores cultural and legal norms that encourage dynastic progression of company ownership and wealth. This ownership structure also promotes a more long-term view by Indian business houses. Unlike institutionalized firms, where bosses have to meet quarter to quarter performance measures, family owned businesses are more focused on creating wealth in the long-term, for the next generation. Thus they invest in frugal products (which, according to the report, do not generate high profits), which is a means to hook the millions of potential middle-class customers of tomorrow.

Overall, though the analysis comes across at times as bit contrived (it works towards the underlying assumption that one size fits all – the institutionalized business models that are successful in the west are the best) and at other times a bit naïve (for example, the report mixes up vertical integration, related diversification and unrelated diversification), the report is well written and worth a read. It raises several key questions and invigorates critical thinking on the state of India’s economic landscape.

If India is to finish the long journey to superpower status that has been plotted for it by many forecasters, it will have to get its act together on things like infrastructure, efficient land allocation, education, bond markets, reliable supply chains and the enforcement of contracts. Yet if it manages to make progress in these areas, the rationale for sprawling big business groups—sometimes almost like mini-states in their own right, as substitutes for the real thing—will gradually disappear. A big danger, then, to Indian business’s current way of doing things is long-term economic success. It would make today’s approach to organising firms redundant.

Read more at Business in India: Building India Inc | The EconomistAdventures in capitalism | The EconomistFamily firms: The Bollygarchs’ magic mix | The Economist, and The Indian miracle and the future: Rolls-Royces and pot-holes | The Economist.

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