BackWe need policy action to fix our problem of the ‘missing middle’
It will take reforms to catalyse the emergence and growth of mid-sized firms that have a vital role to play in India’s economy
PremiumOutperforming emerging economies have one thing in common: a vibrant set of large companies, defined as those with revenues exceeding $500 million, that have expanded faster in scale and scope than those in slower-growth emerging economies. Such companies contribute to economic dynamism in many ways. They tend to be active exporters, play an important role in boosting wages, and spark innovation.
This is also true of India, where about 600 large firms have been significant drivers of growth and innovation. They are more than twice as productive as mid-sized firms and 11 times more productive than the average firm in the economy. They account for almost 40% of total exports, and employ 20% of the direct formal workforce.
The problem is, there aren’t enough of them.
India has fewer large firms relative to the size of its economy than many of its Asian peers. Their revenue, at 48% of nominal gross domestic product (GDP) in 2018, has scope to grow. In China, Malaysia and Thailand, the ratio of large firm revenue to GDP is about 1.5 times larger; in South Korea, it is 3.5 times larger. This pattern holds across sectors. For example, this ratio for retailers in peer economies is up to 13 times larger than in India, while for construction firms, the gap is 7 to 12 times.
Tripling the number of large firms and enabling thousands of mid-size and small firms to climb the ladder of scale would go a long way towards turbocharging the country’s competitive dynamism, boosting growth, productivity, and job creation. This is vital, given the imperative for India to get back onto a high-growth track to create at least 90 million non-farm jobs by 2030, and meet the aspirations of its growing workforce.
We estimate that India needs to enable 1,000 or more small or mid-sized firms to scale up to large firms, and 10,000 or more small firms to scale up to mid-sized firms. For this, we need to fix India’s “missing middle" of competitive mid-sized firms (with revenues between $40 million and $500 million) that can scale up to join the ranks of large firms. India has only about half as many mid-sized firms per trillion dollars of GDP as peer economies. The number of mid-sized and small firms and their upward mobility matters because it influences the degree of competitive pressure that large firms feel. The higher this pressure, the greater the share of efficient and high-performing firms at the top.
Why this missing middle? One factor is the lack of adequate access to low-cost capital. This acts an impediment to growth. A second factor is India’s relatively high cost of doing business and its complicated compliance ecosystem. Small and mid-sized firms face greater problems from these systemic issues, as they have fewer organizational resources to manage lengthy and expensive procedures and litigation responsibilities. For example, enforcing a contract takes up to 1,450 days in India, more than triple the time than in China and South Korea. Moreover, small firms find it challenging to acquire real estate for expansion, obtain construction permits, and pay taxes, all of which take longer in India than in peer countries.
The growth of mid-sized and small firms will require capital—about $800 billion in 2030, or six times the amount currently used, by our estimates. Achieving this requires reforms to deepen capital markets and enable efficient financial intermediation, allowing savings to reach these companies. It will also mean taking steps to lower the barriers to and the cost of doing business. We have outlined a detailed reform agenda in a new McKinsey Global Institute report, India’s Turning Point. If the proposed reforms are successful, the number of large firms in India could rise from 600 to more than 1,800 and their revenue could grow from 48 to 70% of nominal GDP.
Central and state governments will be integral to implementing these reforms, of course, but business leaders will need to play their part too. India’s large firms have not achieved their productivity potential in recent years. Since 2012, their profitability, as measured by return on assets, has also been falling. This needs to change.
We see three main priorities for India’s firms, both firms that are currently large and aspirants who aim to enter this cohort. First, they need to raise aspirations and commit themselves to a set of business opportunities at the frontier of productivity. Second, they need to develop a long-term value-creation mindset, coupled with a strong performance-oriented culture. And finally, they need to develop a set of winning capabilities. These include customer-centric innovation, operational excellence, digitization and automation that boost efficiency, the skills needed to execute mergers, acquisitions and partnerships to scale up, and the ability to build a strong trust-based brand to attract capital, customers and employees.
India’s entrepreneurs are one of the country’s strongest natural endowments. Now is the time to unleash their creativity and nimbleness. The future of the economy depends on their success.
Gautam Kumra & Anu Madgavkar are, respectively, the managing partner of McKinsey & Company in India and a partner of McKinsey Global Institute
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