India

India

It's a major consumer market for multinational companies, but can India become a global manufacturing powerhouse to rival China?

Industrial dawn

Three years ago, on 6 January 2005, India's minister of commerce and industry, Shri Kamal Nath, was addressing the inaugural meeting of the National Manufacturing Competitiveness Council in New Delhi when he issued a warning to the sector: "Our manufacturing competitiveness is yet to reach its potential and this must be addressed as a priority."

The minister insisted that the growth of the sector, at an annual average of 6.3 per cent during 1991 to 2003, was still too low. Manufacturing, he contended, needed to grow by at least 12 per cent a year.

Skip ahead to the end of March 2007, and this ambitious target had already been met. Indeed, for the 2007-08 financial period this growth is expected to reach 14 per cent.

The Indian government's insistence on stepping up industrial production has a clear objective. The country's manufacturing sector accounts for only 17 per cent of its economy, a figure the government is hoping to boost to 30 per cent to close the gap with other East Asian economies such as China, Thailand and Malaysia - all of which have manufacturing to thank for around one-third of their gross domestic product (GDP).

Partly to blame for this relatively small share of manufacturing in India's GDP pie is of course the explosion that its services industry has enjoyed over the past decade. Foreign direct investment in the shape of large Western corporations offshoring some of their customer service, IT or finance activities to a skilled pool of English-speaking Indians has contributed to the rise of an expanding middle class that is helping the country continue with its fast growth path.

But 1.1 billion people live in India, of which only some 50 million can claim to be part of the new middle class, whereas around 300 million still live below the poverty line and lack the education needed to join the offshored services boom.

"If you compare the GDP growth of China and India you will see that China [at around 11 per cent] has a much higher growth than India [around 9 per cent]. And that's primarily because manufacturing investments attract more jobs for lower-educated people and, in general, they also attract more investments than IT or business process outsourcing (BPO) activities, which are, by nature, not very capital-intensive," says Roy Lenders, vice president for consulting services with market research firm Capgemini.

"So I think the Indian government has recognised that, if they are to match the GDP growth of China, they need manufacturing investments next to their IT and BPO investments."

Indian promise

Lenders is one of the authors of a 2007 survey that Capgemini carried out in conjunction with industrial real estate group ProLogis. The resulting report, 'Offshoring evolution - Changing trends in India and China across industries', suggests that the Indian government's ambitions to lure multinational manufacturers currently investing somewhere else are not as unrealistic as they may seem.

The consultants asked 340 companies based mainly in Europe, the Americas and Asia Pacific - but which operate in the subcontinent - about their future plans for India. Most indicated that, while manufacturing was currently their least outsourced activity there behind IT, finance, customer service and reseach and development, they had plans to make it the main activity in less than five years.

Capgemini claims this means India might soon find itself in a position to challenge China's role as the world's undisputed manufacturing powerhouse. "The results actually surprised us," admits Lenders. "I mean, if you look at the current state of offshoring then you obviously find what everybody would expect to see, that is, China being the manufacturing centre of the world and India being primarily active in IT and BPO-type work.

"But when we asked the companies we surveyed about their concrete plans for the next three to five years in India, manufacturing was the number one offshore activity they entioned, surpassing even IT."

Lenders adds: "Most of the companies that we surveyed have already had manufacturing operations in China for eight to ten years. And what a lot of these companies are seeing at the moment is that, because those manufacturing facilities are concentrated primarily along the east coast of China, costs are rising quite rapidly in those areas. They are becoming too expensive compared with other countries in the region.

"So a lot of those manufacturers are evaluating what to do next. And they have a couple of options," Lenders says. "Option one is to move deeper into mainland China - in which case you have the problem that the infrastructure isn't there. The other option they have is to expand in other countries in Asia Pacific. Some of the companies are looking at Thailand or Vietnam, but a significant number of companies are actively looking to India."

A series of factors have combined to make the Indian consumer marketplace highly attractive to the West. With a significantly higher population growth rate than China, it has been estimated that India will have the world's largest population in less than 20 years. And, while the vast majority of the population has not yet been reached by the benefits of an expanding economy, future
sales projections for an increasing list of consumer goods indicate that manufacturers will find it hard to justify not having a presence there. Passenger cars, personal computers, furniture, mobile phones, food products or durable goods are just some of the categories most often cited as already showing phenomenal growth.

According to McKinsey Global Institute, India's consumer market will expand to reach $1.5tr by 2025, which would propel it from it number 12 position to number five in the world behind the US, Japan, China and the UK.

Driving growth

Already one of the largest branches of Indian industry, the auto sector illustrates perhaps better than any other the sheer extent of the untapped domestic market potential. For every 1,000 inhabitants in the US today, there are 477 that own a car. In the UK, this figure is 373. In India, it's just seven cars per 1,000 inhabitants.

However, while European and North American markets have already reached saturation point, passenger car sales have doubled in India over the past five years. Unit sales are expected to jump from the current one million annually to 3.15 million by 2015, practically equalling the number of vehicles sold in the UK and Germany.

The majority of cars produced and marketed in India are designed to meet the growing demand for predominantly small, low-priced vehicles. Motorised two-wheelers remain among the most popular forms of transportation, so Indian auto makers are turning to small and affordable cars as the formula to get millions of drivers to upgrade to four wheels.

In 2003, Ratan Tata, head of Tata Motors, the vehicle arm of the Indian conglomerate, shocked the auto industry by announcing at the Geneva Motor Show that his company was planning to produce a car for only 100,000 rupees (£1,200 at today's prices). The first of these ultra-low-cost models is scheduled to roll off the manufacturing line near Kolkata in 2008.

Tata Motor's main local competitor and market leader in the passenger vehicle market, Maruti, is not ready to wait and see how its rival does with the so-called 'people's car'. The company will respond by dropping the price of its entry-level model by 20 per cent.

So far, Europe's auto makers have shown only a limited interest in India. As much as 85 per cent of all vehicles sold in the country are built by Maruti, Tata Motors and Hyundai. But, given the current economic outlook, market research agency Maritz Research is warning European car makers and suppliers that they might want to reconsider what the subcontinent has to offer.

"An early presence on this market of the future could definitely pay dividends," says Joerg Hoehner, director of automotive research Europe at Maritz. "But it is essential to be aware of certain oddities. For example, the price factor has caused big problems for many foreign brands. High duties keep the Indian market largely insulated from imports, and excessive taxes on imported components push up production costs substantially.

"Therefore, if you want to capture an appreciable share of the Indian market, you have to produce locally. Manufacturers like Maruti make vehicles entirely in India, so they can offer much lower prices to the end customer than any importer."

Making friends

The desire of some multi-nationals to participate in the Indian consumer boom, coupled with the recommendation to produce locally in a market many foreign companies don't know quite intimately enough, has given rise to a number of joint ventures in India. Renault, for example, used this approach to introduce its first model into India - the Logan. The French auto maker joined forces with Mahindra & Mahindra to build 1.4l and 1.6l petrol, and 1.5l diesel engine versions of what Mahindra Renault calls "India's first wide-bodied car" (accommodating three in the back seat).

With an initial investment of 125m, the Logan is currently being produced at a modern factory that Mahindra owns in the city of Nashik, 180km from Mumbai. Featuring a stamping shop, paint shop and assembly line specifically for the Logan, it has a capacity of 50,000 units a year.

The car was launched at the beginning of May 2007, with phase one targeting the cities of Mumbai, Delhi, Kolkata, Chennai, Bangalore, Hyderabad, Pune, Nashik, Chandigarh and Ludhiana. Just a month later, the company was releasing sales figures of 2,786 units, each costing between 428,000 and 644,000 rupees (£5,300 and £8,000). Anand Mahindra, vice chairman of the industrial conglomerate, called it "a product that will appeal to the evolved Indian customer".

Retail and infrastructure are two other industry sectors that are featuring high in the plans of Western companies looking to either establish or expand operations in India, according to Gapgemini. Infrastructure includes not only building construction companies and their suppliers but also telecommunications equipment manufacturers, it says.

India is also the world's fastest growing cellular market, and telecommunications manufacturers are queuing up to take advantage. Nokia, Motorola, Samsung, Sony Ericsson and LG (the five largest mobile phone makers) have already opened factories in the country. Nokia estimates that, by 2010, India will be its second-largest market in terms of volume after China.

Sony Ericsson, which has partnered with contract electronics manufacturers Flextronics and Foxconn to produce ten million handsets from Chennai by 2009, will soon be adding a research and development centre in the same city. And UK-based operator Vodafone invested $2bn in India during 2007 alone.

The booming economy is not only keeping multinationals busy. Indian manufacturers are growing stronger almost by the day. And, according to Gapgemini, the only reason their names are not yet being heard beyond the borders of the subcontinent is because they can hardly keep up with internal demand. Says Lenders: "I think it's safe to say that there are very few large Indian companies which at the moment have global ambitions. But that's partly related to the fact that growth in their own country is so robust at the moment that they have no time to worry about lower-growth markets. I would expect that to start changing at some point in the future."

Uncomfortable ride

However, there remain many barriers, challenges and hurdles that will need to be overcome before India manufacturing potential can be realised. Chief among these is the lack of adequate infrastructure.

The country has insufficient and deteriorated roads, a lack of  energy supply, a shortage of rail freight corridors, poor ports and overcrowded airports. According to Adil Zainulbhai, director of the McKinsey's Mumbai office, the government is investing heavily in all of these areas. Some $34bn of public funds went into improving India's infrastructure during 2005-06,  and an extra $475bn is earmarked over the next five years. However, much more will be needed if the ultimate ambition is to match China's enviable infrastructure.

The country's 'soft' infrastructure shows an equally worrying series of holes. An endemic lack of schools and hospitals, for example, means that an alarming 40 per cent of Indians are illiterate (against 10 per cent of Chinese), while the infant mortality rate is 68 per 1,000 live births (more than double that of China).

Another issue India has still failed to tackle is the overwhelming red tape at the lower levels of both central and state administrations, which has put off major foreign manufacturers. Intel, the world's largest chip maker, had firm plans to set up a new plant in Andhra Pradesh's planned 'Fab City'. For years Intel kept waiting for the national government to issue its policy guidelines for the semiconductor manufacturing industry, which were to detail the special incentives the government was prepared to offer chip makers in order to produce wafers in India.

By the time the guidelines were finally announced in September 2007, Intel had already decided it had had enough of waiting, and its chip factories will end up being built in China and Taiwan instead.

Meanwhile, manufacturers across India continue to call for more flexibility  under what they consider to be excessively rigid labour legislation. By law, any firm that hires more than 100 workers is not allowed to announce any redundancies before obtaining government authorisation. Which, in such a labour-intensive sector as manufacturing, would translate as something like: "Are you sure you want to invest here?" And this is surely a long way from the message sent out by Shri Kamal Nath almost three years ago.

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