Why do small companies remain small in India? And how do they even survive if they are unproductive?
In India’s case a deadly cocktail of economic and non-economic factors inhibits small firms from becoming larger. The economic factors include capital, labour, land and infrastructure, and many of these have played out in the case of SLN Technologies.
Professor Amit Khandelwal, Jerome A Chazen Professor of Global Business at Columbia Business School in New York, throws light on the missing middle. He talks about how, in India, it is very hard to fire workers once they are hired, because of the country’s labour regulations that have remained unchanged for decades.
The country’s labour laws incentivise firms to stay small and hire informal labour.
Capital is required to become a large company. But as we see in SLN’s case, borrowing from banks isn’t easy in India.
“The majority of the lending [is done by] state-owned banks. They discriminate against very small firms. If they come with no collateral, there is no credit bureau to say if the company is trustworthy or not,” says Khandelwal. “Indians get around the problem by borrowing from friends and family, but one can’t build a large enterprise without a functioning credit market.”
Land laws are onerous too. To build new plants, companies have to venture far away from the city, like SLN did. However, converting agricultural land into non-agricultural land is a painful process. Villager movements, the land-grab mafia and agitation by environmental and political groups can stall projects. Tata Motors was constructing a plant to manufacture its Nano cars at Singur in West Bengal, but had to shift production to Gujarat in 2008 after sustained political agitation and violence. The heart of the problem was the accusations against the state government for being unjust to the residents of the land while acquiring the property.
When a plant is located far from the city, one has to additionally worry about infrastructure problems such as bad roads and connectivity to ports and airports. “How to get materials in and out of the plant? Modern businesses operate on small inventories; they want to get the raw material and use it up immediately,” says Khandelwal.
There is little research on the non-economic factors constraining firms, but there are plenty of anecdotes. And they paint an interesting picture.
Less than an hour from Tiruppur is Coimbatore, Tamil Nadu’s second-largest city after Chennai. Like its neighbour, Coimbatore throbs with industrial energy. India’s first finance minister, RK Shanmukham Chetty, was born and raised here – he tabled the country’s first budget on 26 November 1947. Chetty also founded the Indian Chamber of Commerce and Industry in 1929, in this city.
Today, the chamber represents 1,600 members and other affiliated associations.
Not far from the chamber’s office is Siruthuli, an NGO whose name means “tiny drop”. Vanitha Mohan, a rare mix of an eco-crusader and industrialist, heads it. Her NGO has cleaned up seven lakes in Coimbatore. “We would have become a desert otherwise. This is the bore well capital of the country. When we take out water, we have to give [it] back,” she says.
Mohan is the chairperson of Pricol Limited, a company that manufactures automotive components and employs over 5,000 people. This is a company that has scaled up over time.
Our conversation stops at the lingering question: In India, why do small companies remain small, particularly in the manufacturing sector?
“Because they are averse to taking risks. They don’t believe in delegation,” quips Mohan. She implies that most family-owned manufacturing companies don’t prefer delegating to professionals outside of the family.
Mohan and her husband Vikram, Pricol’s managing director, managed to scale up because they delegated. Nonetheless, for most family-run businesses, trust remains a core issue.
“The thinking [is] that these youngsters coming in will blow up a lot of money. [The questions that arise here:] How can I trust him with my money? How can I trust him with decisions? New ideas are looked at with suspicion.”
In 2011, a group of economists from Stanford University, UC Berkeley and the World Bank reported the results of an extensive research carried out in 28 plants operated by 17 firms in India’s woven cotton fabric industry. The idea was to understand “to what extent differences in management cause differences in firm performance”.
“In every firm in our sample, only members of the owning family have positions with major decision-making power over finance, purchasing, operations or employment. Non-family members are given only lower-level managerial positions with authority only over basic day-to-day activities. The principal reason is that family members do not trust non-family members. For example, they are concerned if they let their plant managers procure yarn they may do so at inflated rates from friends and receive kick-backs,” says the report. (“Does Management Matter? Evidence from India”, by Nicholas Bloom, Benn Eifert, Aprajit Mahajan, David McKenzie and John Roberts, 2011.)
The report concluded that the inability to delegate was because of poor rule of law in India. “Even if directors found managers stealing, their ability to successfully prosecute them and recover the assets is minimal because of the inefficiency of Indian civil courts,” say the authors of the report.
Firms remain small in India because they are limited by the bandwidths of their owners. There is only so much an owner can do. The poor rule of law in India doesn’t usually figure in conversations around jobs or the coming job crisis. But there is a cost to justice delayed, and that cost can be employment.
Excerpted with permission from Jobonomics: India’s Employment Crisis and What the Future Holds, Goutam Das, Hachette India.