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As inflation soars, it’s survival of the biggest

In the December quarter, the number of ‘small manufacturers’, with annual sales below  ₹100 crore, saw a 13% drop in revenues from a year earlier.Premium
In the December quarter, the number of ‘small manufacturers’, with annual sales below 100 crore, saw a 13% drop in revenues from a year earlier.

  • Large manufacturers, with their ability to source inputs at scale, have gained share
  • Sectors across the board are seeing consolidation in terms of market share. When prices start rising, it is large manufacturers who are able to aggressively reach out to consumers.

NEW DELHI : This April, a time when wholesale prices were up 15% from a year ago, Hindustan Unilever chief executive Sanjiv Mehta held his quarterly conference call with company analysts. HUL’s turnover had crossed 50,000 crore for the year, and the company itself had seen its biggest market share gains in a decade.

“It was a comprehensive market-beating performance, with share gains in all three divisions, across price segments, across regions, both in urban and rural," he said.

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HUL was not unique in registering market share gains. Dabur’s CEO Mohit Malhotra reported the company’s revenues crossed 10,000 crore for the first time, with 99% of its product portfolio registering market share gains. More importantly, this growth came despite poor growth in volumes. Consumers closed their wallets due to across-the-board price hikes by companies, in the face of a strong increase in price of inputs. It was price growth that fuelled the bump in revenues.

In a research report for the December 2021 quarter, market research firm NielsenIQ reported a year-on-year decline of 2.6% in volumes for the fast-moving consumer goods (FMCG) sector—the logical culmination of a series of price increases by companies over the course of the past year. Yet, the sector grew 9.6% in value terms. For all of calendar 2021, FMCG companies saw 17.5% growth in revenues, driven by such price increases.

But not all companies did well. In the December quarter, the number of ‘small manufacturers’, with annual sales below 100 crore, saw a 13% drop in revenues from a year earlier. In the quarter before that, that drop was 14%. Small manufacturers grew 6% in value terms in the September 2021 quarter, compared with the beginning of the year. Large manufacturers grew at double that pace.

This is a characteristic feature of the FMCG industry, which has numerous small players operating at a regional level. These manufacturers do relatively well at a time of low inflation. But when prices start rising steeply, it is the large manufacturers—with their heft, ability to source inputs at scale and marketing budgets to reach out aggressively to consumers—who are able to pass on increased costs, and do well.

The size advantage

Harsh Shah runs Complete Tank Solutions, an Ahmedabad-based company with annual revenues of 6 crore that makes and fits water tanks. “We compete with bigger companies on prices, quality and service," he says. “Post pandemic, despite a steep increase in raw material prices, we have been unable to increase prices, which affected our margins," he adds.

So, it’s not just FMCG—sectors across the board are seeing consolidation in terms of market share. A Mint analysis found that five companies took in 21% of all profits earned by listed companies in 2020-21, up from 17% six years ago. In about a third of 20 industries analysed, the top five companies earned about 90% of profits.

Data from India’s central bank on around 2,700 listed non-government and non-financial companies shows that quarterly sales growth for large companies (annual turnover above 1,000 crore) has been in the range of 23-26% since the fourth quarter of 2020-21. In contrast, sales growth for smaller companies (annual turnover below 100 crore) has been patchy, often negative.

When it turned positive, it never went above single digits during the same period. Similarly, operating margins for large companies in the same period were in the range of 16-19%. For smaller companies, margins topped out at 7.6% through the entire period. For companies with a turnover of below 50 crore, margins remained negative throughout.

These patterns hold true if we broaden the scope to unlisted and listed firms as well, and look at the data over a longer period. An analysis from the Annual Survey of Industries, which covers data across a wider range of listed and unlisted companies, shows that 40 of 78 sectors saw the top 3 companies in them increase their market share (in terms of gross sales) between 2011-12 and 2018-19.

Hence, the sectoral consolidation in many industries is not just a cyclical change, as may be the case in FMCG. Last year, credit rating agency Crisil forecast that the top 10 cement manufacturers will account for 70% of the new capacity addition in the industry till 2024, taking their share of capacity to 65% by that year—up 9 percentage points from 2015-16.

Further, in a recent analysis, Crisil said that more than a quarter of India’s micro, small and medium enterprises (MSMEs) lost market share of over three percentage points during the pandemic, while half of them suffered a contraction in earnings because of the sharp rise in commodity prices in the previous year.

“We have to deal with price fluctuations on a daily basis," says Vijay Agarwal, who runs a small enterprise in Delhi manufacturing PVC cables. “If raw material prices continue to fluctuate like this, larger companies will dominate."

Implications for inflation

Inflation in both consumer and wholesale prices has soared since the beginning of last year. Many factors, with their roots in the pandemic lockdown, such as high global freight rates, initially kicked off the inflationary surge. Since the beginning of this year, it has been the war in Ukraine that fuelled the price rise in key commodities like oil and fertilizers.

The Wholesale Price Index (WPI) was at 15.18% for June 2022, while the Consumer Price Index (CPI) was at 7%. In January 2021, WPI was around 2.5% and CPI around 4.7%.

In an interview to The Indian Express, former chief statistician Pronab Sen spoke about the implications of this consolidation of market power across sectors, noting that the MSME sector had been ‘decimated’ and that pricing power had “shifted". He argued this might lead to CPI converging towards WPI, rather than the other way round, as is usually the case.

A similar sentiment was expressed by professor Jayanth R Verma, a member of the Reserve Bank of India’s Monetary Policy Committee in December 2020. He said: “Anecdotal evidence suggests that in several sectors which are characterized by an oligopolistic core and a competitive periphery, the oligopolistic core has weathered the pandemic well and it is the competitive periphery that has been debilitated. Rising profits and profit margins, improving capacity utilization and lack of new capacity additions create ripe conditions for the oligopolistic core to start exercising pricing power."

Three big challenges have hit Indian industry since 2015: demonetization, the introduction of the goods and services tax (GST) and, lastly, the covid-19 lockdown.

“For us, operating cash is a major part of how we can increase business," explains Harshil Shah, managing director of Baroda Gas & Trading Corporation, a Vadodara-based small enterprise dealing in industrial and food-grade sodas. “With GST and demonetization, our cash is either tied up with customers or the government. We have had to take an operational loan twice, which we wouldn’t have otherwise. Larger companies don’t have these constraints and even have teams for regulatory operations. Here, everything is handled by one or two people," he says.

The proportion of bank credit to MSMEs had steadily declined after the 2008 financial crisis as banks became risk-averse in the face of rising non-performing assets (partly caused by ‘over-lending’ to large corporates). An RBI study in 2018 found that “credit growth in the MSME sector had started decelerating even before demonetization, and declined further during the demonetization phase."

During covid itself, the government introduced the Emergency Credit Line Guarantee Scheme (ECLGS) to provide additional liquidity to the MSME sector. The scheme increased the sector’s access to loans significantly. But this scheme was still just a lifeline to enable businesses tide over the short term. Close to three-fourths of the loan amount disbursed was used to restart business operations or pay off dues to existing vendors, according to a report by credit bureau CIBIL on scheme outcomes.

Even before covid, though, the gap between what Verma described as the “oligopolistic core" and the “competitive periphery" was stark. An analysis of unit level data of the results of over 14,000 companies released by the Ministry of Corporate Affairs for 2018-19 shows that in 15 of 28 sectors, the median operating margin of the top 10% of firms (by revenue) was higher than the median operating margin of the remaining 90% of firms. Interestingly, sectors that were larger in size (by total industry revenue) were more likely to see the ‘core’ firms have better margins than ‘periphery’ firms.

What causes what

But how does the chain of causation go? While Verma and Sen both argue that the causation runs from the change in ‘market structure’ in economist-speak (industries becoming more oligopolistic), as the example of the FMCG industry above shows, the causation may well work the other way round as well.

When the cost of raw material inputs in world markets increases sharply, all industries are forced to pass on the price increases to customers. Otherwise, they wouldn’t stay in business. However, larger firms are able to source inputs and materials in bulk and more efficiently. Smaller firms, therefore, face challenges to staying competitive.

“Larger companies have deeper pockets," says Maulik Patel of Vision Medical Private Limited, a trader of medical equipment with annual revenues of about 26 crore. “Our payment cycles are very delayed, especially with GST. If working capital issue is solved, even smaller companies can compete."

As Pushan Sharma, director, CRISIL Research, said, in relation to the recent CRISIL report on SMEs: “SMEs in several sectors saw market share loss…For instance, the pandemic-induced supply chain disruptions impacted small pesticides manufacturers more. On the other hand, large ones leveraged their global presence to procure raw materials, so could eat up a huge chunk of the SME pie. Edible oil SMEs lost market share because an increase in hygiene quotient because of the pandemic meant less buyers for oil sold loose."

HUL, in its conference call to analysts, for instance, talked of the metric of ‘net materials inflation’ (NMI). This is the inflation the company faced after “adjusting for the benefit of our buying efficiencies, hedging, product design or redesign to value and other savings". For HUL, this NMI was 4.5 times the March quarter of 2022, compared with June 2020.

While this was “unprecedented" according to HUL, it is worth noting that WPI in March 2022 was close to 15%. In June 2020, WPI as a whole was in negative territory. “Despite this unprecedented level of inflation [in NMI], we have been able to keep our margins almost flat versus last year and have grown significantly ahead of the market," said HUL’s Mehta to analysts.

The pattern

Small firms are unlikely to have such buying power. In a 2000 study of firms in 11 US industries, economists Robert S Chirinko and Steven M Fazzari found that inflation had a positive impact on ‘market power’ (the extent of oligopoly in an industry and hence the ability of a company to set its prices or pass on price increases to customers).

Depending on the industry, though, this process may or may not be reversible. While periods of high inflation may see smaller players exit, as and when inflation stabilizes and the prices of key inputs hold steady, these players may re-enter the market. In some sectors, such changes in market structure are likely to be more or less permanent, since large existing players have managed to build up huge capacities and market share, which are essentially unassailable without massive investments.

Having said that, the CRISIL report also highlights cases where MSMEs have managed to improve market share. “The readymade garment industry, with 70% MSME share, gained from supply constraints in China and from emerging global opportunities. Pharma exports soared on pandemic-related demand, even as the domestic industry was struggling with lower volume demand," Elizabeth Master, associate director, CRISIL Research, points out.

The implicit assumption in all discourse up to the present has been that the current bout of inflation is cyclical—it will eventually dissipate. But as and when it does, the changes it brings about in terms of industry concentration and the transformation of individual industries may be far more enduring. is a search engine for public data.

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