Saturday, March 25, 2006
The Shape of Indian Multinationals
The official opening of the James E. Lynch India & South Asia Business Centre at Leeds University Business School by His Excellency Kamalesh Sharma, High Commissioner of India in the UK could not be more timely.
India is emerging fast in the world economy, and the recent increase in the number of mergers and acquisitions of UK and European firms by their Indian counterparts has recently made the headlines. Recently, these also triggered tense political negotiations between 'Corporate India', Heads of States and governments at both national and supra-national levels.
India is everywhere. Or rather, Indian success stories are everywhere. We all know and read about the success of the IT industry in Bangalore, the shift of jobs from the UK to India, the huge disparities in levels and distribution of wealth. What else do we know? What do we know about the challenges ahead, not only for India itself, but for the Western world too? What do we know about the way Indian firms are managed? Or about the way they compete in the world economy? What do we know about the demographic challenge that will affect us all -which will be far more significant in shaping India and the rest of the world than the success of the IT industry in Bangalore?
The truth is we know very little about India, its firms and the specificities of its business and management practices. Leeds University Business School, ranked third in Europe for the quality of its research in the latest FT rankings, sought to address the widening gap that exists between inches devoted to Indian success stories in our media and the state -and the quality of our knowledge.
Indian Overseas Investments
Indian firms have been investing abroad for a long time, but it is only in recent years that Indian FDI has become prominent. The United Nations identified two waves in the Indian foreign investment process, the first taking place in the 1970s and 1980s, and the second since 1992. The characteristics of these two waves are fundamentally different.
Throughout most of 1970s and 80s, Indian overseas investment took place mostly in the manufacturing industries -65% of these were in low- and mid-tech manufacturing industries- in countries with levels of development similar to, or lower than, those of India, and were motivated by access to larger markets, natural resources, and by the desire to escape government restrictions on firm growth in their home market.
More recently there has been a dramatic shift in the profile of Indian overseas investments. The share of manufacturing declined to 40% while the service industries now constitute the bulk of Indian foreign investments (60% of equity value). Western Europe and North America have become the main destinations, in particular the UK and the USA.
If Indian investments in the UK are not new, the means used to enter the UK market have changed dramatically over the past decade. The emergence of mergers and acquisitions (M&As) as a mode of internationalisation for Indian firms is what has attracted recent media interest. As many as 119 overseas acquisitions were made by Indian firms in 2002-2003, mostly in the software, pharmaceuticals and mining industries. The bulk of these M&As took place in the USA and the UK. Indian firms are increasingly using M&As to venture abroad to access markets, technologies, strategic assets and operational synergies.
Not all investments originate from large multinational firms (MNEs). Indeed overseas direct investment approvals by Indian small and medium-sized firms (SMEs) accounted for 26% of the cases of manufacturing activities and 41% in the software industry. Software SMEs contributed significantly to the stock of Indian investment abroad, whereas manufacturing investment by SMEs was small. SMEs in the software industry are disproportionately more internationationalised than SMEs in the rest of the economy, and this reflects the competitiveness of Indian SMEs in software activities. The software industry is skill-intensive and largely dependent upon foreign markets, and these characteristics have encouraged Indian SMEs to operate abroad.
The Shape of Indian Multinationals
The quasi-totality of Indian overseas investment in the manufacturing sector is made by large firms. Unlike in Western Europe and North America, large firms in emerging markets such as India are often conglomerates. While managers in the West have dismantled most conglomerates assembled in the 1960s and 1970s, the large, diversified business group remains the dominant form of entreprise in India and throughout most emerging markets.
In an article published in the Harvard Business Review some time ago, Tarun Khanna and Krishna Palepu attempted to identify how these Asian conglomerates created value in their home country. If Western firms have been advised for over a decade to follow the 'small is beautiful' mantra and focus on their core competencies, why are many successful Asian firms large diversified businesses? A significant share of Indian GDP is accounted for by a handful of very large, diversified businesses - some of which operate in as many as 50 unrelated business areas.
Khanna and Palepu pointed out that what we call 'emerging markets' usually fall short in providing the institutions necessary to support basic business operations. They argue that highly diversified business groups can be particularly well suited to the institutional context in most developing countries.
In product markets, buyers and sellers typically suffer from a severe dearth of information as a result of poor communications infrastructure, lack of reliable information and inefficiencies in legal systems. Although the number of mobile phones has been increasing at a rate of 1 million every month in India over the past few years, vast stretches of India remain without telephones. Power shortages often render the modes of communication that do exist ineffective. Then, even when information about products does get around, there are no mechanisms to corroborate claims made by sellers. Independent consumer-information organisations are rare, and government watchdog agencies are of little use. The few analysts who rate products are generally less sophisticated than their counterparts in advanced economies.
Finally, consumers have no redress mechanisms if a product does not deliver on its promises. Law enforcement is often capricious and incredibly slow.
Because information is not available or is of little use when it does exist, firms in emerging markets tend to face much higher costs in building credible brands than their counterparts in advanced markets. In turn established brands wield tremendous power. A conglomerate with a reputation for quality products and services would use its group name to enter new businesses, even if those businesses were completely unrelated to its current lines. Groups also have an advantage when they try to build up a brand because they can spead the cost of maintaining it across multiple lines of business. Such groups then have a greater incentive not to damage brand quality in any one business, because this will undoubtedly affect their reputation in their other businesses as well.
Lack of reliable information in capital markets means potential investors are unwilling to invest in unfamiliar ventures. Well developed instititutional mechanisms in the Western world minimize these problems. However, most of these are either absent or ineffective in emerging markets. Conglomerates can use their established record of providing returns to investors to access external capital markets.
They can also use their internally generated capital to help grow new activities or enter new businesses. Besides acting as venture capitalists, third-world multinationals also act as lenders to smaller existing members of the diversified group, that would otherwise be too small to secure access to capital if they were stand alone businesses.
The labour market of most emerging economies is characterised by a scarcity of well-trained and educated people. Developing human capital becomes a challenge in such a context, and this provides firms with an incentive to develop their own corporate training programmes, and spread the cost among businesses within the group. Firms can also bypass the rigidities of labour markets in most emerging countries by developing their own internal labour market. This provides the firm with the flexibility that it needs to operate in what is often a challenging environment - employees can be transferred from one business to another within the same group when market conditions change - thus making best use of available talents.
Filling institutional voids is therefore the key raison-d'etre of third world multinationals. Given the UK's increasing exposure to M&As from emerging countries' firms such as India's, appreciating the shape of third-world multinationals and understanding its drivers will no doubt be on top of the agenda in the boardrooms and the minds of CEOs of UK and European firms, that might find themselves considering a take-over offer from the likes of Tata and Reliance.
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Nicolas Forsans is Director, James E. Lynch India & South Asia Business Centre (ISABC), Centre for International Business, University of Leeds. He can be reached at N.Forsans@lubs.leeds.ac.uk
Copyright Nicolas Forsans - James E. Lynch India & South Asia Business Centre (ISABC), Centre for International Business, Unlversity of Leeds (CIBUL), Maurice Keyworth Building, Leeds LS2 9JT, England
