Sunday, September 13, 2015

“Too Big to Fail” versus “Too Small to Grow”: A Few Perspectives from the Indian and Japanese Micro Business Ecosystems

Indian business and industrial ecosystem has no exit or bankruptcy provisions as in the US. In fact, Indian business ventures are expected to be resilient in adversities and aggressive with opportunities. Like the oriental philosophy, the spirit of the enterprise is expected to linger on for perpetuity. This is rightly so as India needs to be on a virtuous cycle of continued growth and employment in its quest to reach its full potential. With resources being scarce, a completely capitalistic view (survival of the fittest) or a completely laissez faire view (the markets will eventually correct) are perhaps not so appropriate for the Indian economy at this stage. The Indian Governments as well as economic experts have been supportive of the perpetuity approach.

That said, failure (which starts with loss of competitiveness and ends with close of sales) is also an inevitable consequence of a globalized economy and fragmented industry structure. While there have been stories the world over of failures being turned around into successes, the preferable option is not to fail at all. In this context, the declaration by the Indian Union Government of two of the largest banks in India the State Bank of India and the ICICI Bank as being “too big to fail” comes as a fresh thought, probably taking off from the viewpoints that emerged after the 2008 global financial crisis. The markets, however, did not seem impressed. The declaration possibly needed to be backed up with concrete initiatives to achieve strong profiles. Also required is an approach to remedy the constraints that keep small scale firms too small to grow.

Big may be bountiful, but….

In developed economic ecosystems, big is considered bountiful.  Size is considered to bring advantages of economies of scale and scope, and providing several levers for driving business competitiveness. Growth, however, is a function of time and effort. It is also a function of adjacency of several related businesses. If one looks at the Indian automobile industry, there is clearly a difference between the bigness of a company like Tata Motors which manufactures virtually every type of four wheeler (Car, SUV, LCV, MCV and HCV) versus the bigness of Maruti Suzuki which specializes only in passenger cars. Similar examples of specialized scale versus diversified scale can be found across industries. Management gurus have not yet figured out when and how adjacencies must be actively sought out to achieve bigness or, on the contrary, when and how they turn out to be disincentives for growth.

The aspiration for bigness as an end in itself is a deeply ingrained characteristic of human behaviour. Bigness is taken as the marker for achievement. Listings of the largest firms by leading business magazines such as Fortune and Forbes abroad or Business Today or Business India in India have only positioned the concept of big being praiseworthy in an unassailable way. Bigness has negative consequences for the firms, industries and economies too. Apart from vulnerability to smaller and nimble competitors, in economically adverse situations they are sharply impacted. As an example,  a free fall in oil prices (imagine a deep slump from USD 100 to a forecast USD 20 per barrel), oil exploration firms are not only roiled for short term performance but also forced to drastically prune investments for the long term. Steel giants in India that have grown with huge reliance on debt are negatively impacted by the decline in global steel demand and pricing. As long as bigness is accompanied by deep cash, the advantage of being big sustains through the crises.

Small is essential

Big may be bountiful for developed countries but for emerging economies like India small is still critical. India can be considered to be a pioneer in encouraging setting up of small scale enterprises, from the early days of independence. In fact, the emphasis on cottage industries was a well merited approach towards sustaining and developing rural artisanship, individual craftsmanship and distributed self-employment. The reason for the lukewarm impact of this pioneering effort can be attributed to ignorance of the need for, and challenges of, integrating high technology with low scale in the small scale sector. Reverting to the case of automotive industry or aerospace industry, nuts, bolts and washers or springs could be simple to make but need complex technology for quality and endurance, which in turn calls for major investments.

There are areas where technology, in recent years, has helped small enterprises in marketing, and to an extent even in design. However, manufacturing continues to present major challenges for integration of high technology and small scale. India’s success in Make in India theme would depend on how this complex challenge is tackled. India’s new start-up economy is highly encouraging but given its preponderant orientation towards services and information technology, it hardly offers a solution for the small scale industry’s manufacturing owes and resource constraints. High technology equipment and new generation materials require investments which the small scale sector can ill afford while skilled scientists and engineers are not easily attracted to small enterprises. Low entry barriers to setting up of manufacturing enterprises in small scale in India only compounds the difficulties.

Big for small  

India needs a different paradigm. Angel funding rushes in to sectors and firms where it anticipates huge valuations or good returns. It is unlikely to venture into areas of manufacturing which require high investments for high technologies on one hand but are driven down by low margins of supplies to big customers who have immense bargaining power on the other. Big customers would need to take a broader perspective on this front, leveraging what could impact their income statements vis-à-vis balance sheets. In short, they would need to set up a venture capital pool to support small scale manufacturing enterprises. In a sense, it could be a revert to the early days of industrialization when big companies, mostly public sector units, set up their exclusive ancillary estates to enable contiguous, parent-supported manufacture.

Such exclusivity has, over the years, been eroded by the desire of small and medium units to seek wider markets even as big firms started feeling the responsibility of nurturing units as being uneconomical. The concept of big units sponsoring the smaller ones, however, continues to be relevant. Industrial parks which house the parent corporation and ancillary units is a common feature in modern India as well as developed countries. The challenge to corporations and such small units is how the growing smaller ones can be weaned away from nurturing and how new small units can come into play independent of such sponsorship. The earlier Small Industries Development Bank of India (SIDBI) and the current Government’s Micro Units Development and Refinance Agency (MUDRA) are evidences that the Indian governments are well aware of the need to support the small. The need, however, is for a more intensive and a more cohesive effort as in Japan.  
Japan’s SME ecosystem   

For people used to seeing only the big Japanese brands, it would be a revelation that small and medium enterprises account for 99.7 percent of all firms, over 70 percent of employment and more than 50 percent of all value added in the manufacturing industry. Japan’s industrial policy under SME Basic Act viewed SMEs, including micro units, as diverse, dynamic and independent drivers of manufacturing industry. The Japanese Government promulgated a host of acts and set up several agencies including an exclusive university system, a dedicated financial corporation and credit reinsurance support for SMEs. The policy, which also provides for lower income tax rates, recognized that SMEs have weak assets and lack access to finance as well as human resources and established a total SME ecosystem under the control of Ministry of Economy, Trade and Industry (METI). Annual budgets provide for significant financial support to SMEs. Large units also enrich the SME ecosystem through technological support, deputation of retired personnel as mentors and acceptance of single-sourcing. They realize that the hidden strength of their component makers underpins their own end-product quality.

While India may have all the structures and processes, lack of adequate and focused budgetary support as well as public sector funded and appropriately leveraged credit enhancement and credit reinsurance schemes is a lacuna. More importantly, Japan SME policy succeeds because of the uniquely Japanese obsession with technology and quality as well as development of human resources. A great example is the project to upgrade strategic core technologies to support automobile and engineering industries. Under this, 22 specific core manufacturing fields were identified to upgrade technologies and processes through experimental research and commercialization. As a result, and as an example, precision forging replaced raw forging plus machining for select automobile parts, saving costs and improving quality. In consumer products, ceramic and pottery industry collaborated with fountain pen industry to develop highly precise and elegant porcelain fountain pens.

As part of improving access to skilled human resources for SME sector, 9 universities were set up in Japan exclusively for SMEs. Trade and business organizations to support start-ups and enable overseas business expansion were also set up. While India may have all of these initiatives in some measure or the other, what differentiates the Japanese SME ecosystem is the integrated governmental approach which not only conceptualizes programmes and provides budgetary support but also monitors and counsels SME sector in terms of specific technology and business deliverables. Indian Governments and Industries would do well to study the Japanese SME ecosystem and transfer relevant paradigms that could transform the Indian SME and Micro sector from the image of low cost and low quality to one of high technology and competitive cost with access to State-funded and private-participated credit enhancement and skill honing institutions.

Posted by Dr CB Rao on September 13, 2015

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