Manufacturing in India has truly come of age in recent times. It appeared as if it might contribute 5-6% more to the gross domestic product (GDP), until the economic crisis. A recent survey of 700 manufacturing firms across the country for the National Manufacturing Competitiveness Council shows that the leaders of this revolution were mid-size firms that had the right mix of product variety and volume to serve domestic and global markets. The large majority of firms in the country, however, are small, and these firms need to play a new cutting-edge, long-term role in the economy.
The average financial and operational performance of Indian firms has been quite satisfactory over the last few years, with average net pre-tax profits of around 12%. While Indian firms have worked hard to “get their quality right”—there have been substantial gains in that direction—innovation and research and development (R&D) have received the lowest priority. Their scale of operations remains well below their global counterparts, while supply chains remain inefficient as coordination across the chain is weak, leading to high variance in delivery lead times. Small firms struggle to reach the market due to the absence of appropriate market-makers. Firms, interestingly, perceive themselves to be less competitive on price as compared with their global customers.
Illustration: Jayachandran / Mint
There have been gains, particularly among the medium-size firms in the north—where strategies have been better aligned to size—and among some focused clusters in the south—where newer sectors and foreign firms have created new value. But there has been, to the country’s detriment, intense fragmentation in the east and west, reflecting a serious imbalance in terms of capabilities and performance.
What should worry policymakers is that when the economy recovers, inventories will have disappeared and many players in most supply chains will have collapsed. This means it will take much longer for most supply chains to reconstruct themselves and contribute to the productive economy. The challenge this summer will be to not let the foundation of our industrial economy weaken, despite the waywardness of the financial sector. The crisis in manufacturing has highlighted some inherent weaknesses in our approach which need to be urgently addressed.
Large-scale migration from rural India to urban centres, as well as the youth labour bulge, require major investments and programmes in skill building. Investment in training by firms has been low. Consequently, many get locked into low-quality manufacturing and are unable to serve orders requiring the sort of precision manufacturing that leads to high value addition. Our survey shows that most firms do not have people with advanced degrees such as MTech or PhD. Small firms are unable to hire engineering graduates, restricting their ability to undertake technology-driven advances.
We need to put in place policy interventions such as the development of computer-based training modules for self-learning. Additionally, we need to recognize firm-level, in-company training as an equivalent to an Industrial Training Institute diploma, and allow a fraction of the firm’s tax payable to be kept in an escrow fund and earmarked for training of employees, thereby ensuring that each employee receives a minimum annual training. State governments should put programmes in place to pay for 40 hours of skill-based training annually for three years for every youth until he or she reaches 18 years of age. Each district must have technology-driven training centres set up by private enterprises, where students will be funded, with special emphasis on encouraging women. This will go a long way in building long-term national capabilities.
Small firms in India want to become ancillaries to large firms so that they can obtain regular orders for the same component. This sets them at a cost disadvantage from a large competitor with scale economies. They consequently try to compete by externalizing the costs to society, keeping wages and the quality of workers low, and not investing in technology. Small and medium enterprises (SMEs) are most effective when producing high variety at low volumes, thereby becoming R&D centres for large firms.
In our survey, less than 10% of small firms—the most promising and profitable ones—follow this strategy. Small firms must compete on distinctive capabilities and not on low wages. Government policies should encourage—with funding, if necessary—engineers and scientists to set up or convert to flexible processing firms, such as cutting-edge machine tool operations, where the small firm conducts R&D to improve its processes and serves the needs of multiple customers. Large firms are assured of process R&D by SMEs so that they can focus on product R&D and management of supply chains, while small firms are assured of a diverse customer base. This is a robust model, especially in times of economic downturn.
The current problem is to find products with reasonable demand. Customers are currently only spending on goods they need. Small firms that are customizing production to this need are doing well. Wherever firms have started to service customers through customized service, they have been able to create a niche market. Perhaps this is a unique Indian model of production. The need is to extend this model to a cluster of small firms, each producing a distinctive variety and coordinating their production and sales so that the network acts like a large firm, even when all its members are small.
Small manufacturers in particular suffer from bureaucratic controls and permissions, interference by local government officials, complex processes, elaborate paperwork, delays at customs and ports, and stoppage of goods on highways by road transport officials. These procedures impose enormous transaction costs and, as a result, running a manufacturing operation has become very difficult. It is, therefore, hardly surprising that most young people shy away from starting and managing such enterprises. Modest changes such as self-certification of taxes, payment of all transport charges at departing destinations, single-day processing to set up a firm, all reduce government interference and are urgently required.
India remains a laggard in terms of investment in innovation and R&D. About 1% of GDP is spent on R&D and most of it comes from the government. Industrial policy must demand patents or proof of innovation before offering subsidies on tax and other benefits to firms. Government laboratories should have market linkages. Once the strategy for SMEs is reset, they could become the key agents of innovation in the industrial sector. The government must guarantee matching funds to all young graduates who have patents in order to commercialize their innovations into enterprises.
The slowdown in the economy will lead to restructuring of the manufacturing sector and many firms will down shutters. The only question is whether our policies will facilitate the rise of a new manufacturing firm that is innovative, productive and flexible. This will build capabilities to make the manufacturing sector in India the “laboratory of the world”.
Pankaj Chandra is professor of operations and technology management and director of the Indian Institute of Management, Bangalore. Your comments are welcome at firstname.lastname@example.org