Consolidate or perish

D. Sampathkumar

IT IS a Chinese threat. But this one has little to do with the boundary dispute that has bedevilled relations between the two nations for well over four decades now.

It is about manufacturing capability. Sections of industry have been quite agitated over the flood of Chinese consumer products in the market. They have a point.

Chinese goods are gobbling up market share in some segments of the consumer electrical and electronics industry at a rate that threatens to wipe out domestic manufacture faster than anything that developed nations may have dreamt up under the WTO regime. They have succeeded in their efforts at market penetration through some aggressive pricing.

Given the cost structure of domestic manufacturers, it is inconceivable that they would ever be able to make transistorised radio receivers or dry cells -- the two classes of goods that face the brunt of competitive pressure from Chinese manufacture -- at the prices at which the Chinese equivalents are sold in the market.

Reports suggest that these goods are going at a third, or even fourth, of the prices at which the domestic offerings are available. With this kind of cost differential, the Government would have to pull out the entire range of protective measures -- tariff, quantitative, exchange rate, etc., if there is to be any hope at all for the domestic industry to build a fortress of protection around its business. That seems very unlikely.

But in all the excitement over the so-called dumping of Chinese goods in the Indian market, a larger point seems to have been overlooked. Indian enterprises, at least many of them, have a long way to go before they can claim to be up there among the best in the world in competitiveness.

Such, indeed, has been the pressure on them to maintain their market shares that they were unable to raise prices on their products lest they lose out to competition from abroad. This becomes clear if one analyses the trends in financial performance in recent years put out by the Reserve Bank of India (RBI). The analysis shows that the Indian corporate sector has generated a compounded rate of return of a mere 7 per cent on shareholder funds in 1997-98, the latest year for which RBI data is available.

The root cause of the problem for Indian industry has been the huge investments made in capacity creation post-1991. That such huge investments stemmed from the euphoria of both overseas and Indian investors about prospects for Indian industry is well-documented. But it also succeeded in putting tremendous pressure on domestic enterprises to retain market shares. They were able to do so by the simple expedient of holding the price line.

But despite such self-denial, collectively the corporate sector could not generate significant improvements in capacity utilisation. Consequently, bottomlines were affected by the impact of a pincer movement of forces.

Poor capacity utilisation has meant that fixed costs could not be defrayed on a larger volume of sales. Additionally, investments in capacity creation, to the extent these were financed out of borrowings, has also meant that interest costs continue to be a dominant factor of cost in operations despite a softening of interest rates in the economy. That explains why net profits have not grown even at the rate at which sales grew in recent years.

What, then, are the prospects? In large segments, industry is highly fragmented. In the food and beverages segment, for instance, more than 450 units collectively account for a turnover worth Rs 45,000 crore. This makes most players seem puny by international comparison.

The presence of so many players implies that none of them is really able to leverage adequately the infrastructure created in distribution and logistics management for handling their output. The numbers have to come down substantially and the field would then be open for the surviving units to formulate an appropriate strategic response to competition from overseas, be it Chinese or of some other origin.

The future winners would, however, still have to conform to certain characteristics in their operations in order to succeed, going by the handful of success stories. The winner is likely to be someone with deep linkages up and down the product value chain. This is vital in a process industry, though no less valid in other segments of the manufacturing sector.

Thus, Reliance Industries, with linkages going all the way back into oil exploration and refining, and upstream into petrochemicals, man-made fibre, yarn and textiles, has a better chance of succeeding in the market place than a company which is exclusively into fabric production sourcing even yarn from outside. A skewed tax structure makes consolidated operations doubly attractive. The country has a federal political structure, and this means there are both State and Central levies. Since taxes paid under one framework cannot be offset under the other, integrated manufacturing offers the best bet against the cascading effects of taxation.

Integrated operations are useful from another perspective too. They take the company that much closer to the ultimate consumer. And the closer a company is to the consumer, the better it is equipped to create value propositions in the latter's minds. It can resort to premium pricing strategies and yet create an image in the consumers' minds that they are getting value for their money.

For instance, in the paint industry, those engaged in the manufacture and marketing of paints have done better than those engaged purely in dyes and pigments, which are intermediate goods. The latter, being typically a commodity business, has suffered an erosion in profit margins.

The lesson from corporate performance in recent times is this. The future winners, if one leaves out the computer software industry, are likely to be found primarily among players engaged in manufacturing and in services for the ultimate consumer, particularly those demonstrating an extraordinary degree of integration of operations in the value chain.