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Building Capabilities to Make Manufacturing in India the “Laboratory of the World”

Pankaj Chandra
April 19, 2009

Manufacturing in India has truly come of age in recent times. It was appearing that it may contribute five to six percent more to the GDP until the economic crisis crippled the world. A recent survey of seven hundred manufacturing firms across the country, done for the National Manufacturing Competitiveness Council, reveals that the leaders of this revolution were mid-size firms that had the right mix of product variety and volume to serve the domestic and global markets. The large majority of firms in the country, however, are small and these firms need to play a new cutting-edge, long-term role in the economy.

The average financial and operational performance of Indian firms has been quite satisfactory over the last few years with average net pretax profits around 12 percent. While Indian firms have worked hard to “get their quality right” – and there have been substantial gains in that direction – innovation and R&D have received the lowest priority. Their scale of operations remains well below their global counterparts, while supply chains remain inefficient as coordination across the chain is weak, leading to high variance in delivery lead times. Small firms struggle to reach the market due to absence of appropriate market makers. Firms, interestingly, perceive themselves to be less competitive on price as compared to their global customers. While there have been gains, particularly amongst the medium-size firms in the North – where strategies have been better aligned to their size – and amongst some of the focused clusters in South – where newer sectors and foreign firms have created new value – there has been, to the country’s detriment, intense fragmentation in the East and West, reflecting a serious imbalance in terms of capabilities and performance.

What should worry policy makers is that when the economy comes back up, inventories will have disappeared and many players in most supply chains will have collapsed. This means it will take much longer for most supply chains to reconstruct themselves and contribute to the productive economy. The challenge this summer will be to not let the foundation of our industrial economy weaken, despite the waywardness of the financial sector. The crisis in manufacturing, though triggered elsewhere, has highlighted some inherent weaknesses in our approach, which need to be urgently addressed.

Large scale in-migration from rural India to urban centers, as well as the youth labor bulge, requires major investments and programs in skill building. Investment in training by firms has been low. Consequently, many get locked into low quality manufacturing and are unable to serve orders requiring the sort of precision manufacturing that leads to high value addition. Our survey reveals that most firms do not have people with advanced degrees like MTech or Ph.D. Small firms are unable to hire engineering graduates, restricting their ability to undertake technology-driven advances. We need to put into place policy interventions such as the development of computer-based training modules for self learning. Additionally, we need to recognize firm-level, in-company training as equivalent to an ITI diploma, and allow a fraction of the firm’s tax payable to be kept in an escrow fund and earmarked for training of the employees, thereby ensuring that each employee receives an annual minimum training. State governments should put programs into place to pay for forty hours of skill-based training annually for three years to every youth till he or she reaches eighteen years of age.  Each district must have technology-driven training centers set up by private enterprises, where students are funded, and with special emphasis on encouraging women. This will go a long way in building long-term national capabilities.

Small firms in India desire to become ancillaries to large firms so that they can obtain regular orders for the same component. This sets them at a cost disadvantage from a large competitor with scale economies. They consequently try to compete by externalizing costs to the society, keeping wages and the quality of workers low, and not investing in technology. Small and medium enterprises (SMEs) are most effective when producing high variety at low volumes, thereby becoming the R&D centers for large firms. In our survey, less than ten percent of small firms – the most promising and profitable firms – follow this strategy. Small firms must compete on distinctive capabilities and not on low wages. Government policies should encourage – with funding, if necessary – engineers and scientists to setup or convert to flexible processing firms, such as cutting-edge machine tool operations, where their small firm conducts R&D to improve its processes continuously and serves the needs of multiple customers. Large firms are assured of process R&D by the SME so that they can focus on product R&D and management of supply chains, while small firms are assured of a diverse customer base. This is a robust model, especially in times of economic downturn.

The current problem is to find products with reasonable demand. Customers are currently only spending on goods that they need. Small firms that are customizing production to this need are doing well. Wherever firms have started to service customers through customized service – small-batch production, producing in variable production lot sizes, or dispatching at short lead times – they have been able to create a niche market for themselves. Perhaps this is a unique Indian model of production. The need is to extend this model to a cluster of small firms; each producing a distinctive variety and coordinating their production and sales such that the network acts like a large firm, even when all its members are small.

Small manufacturers in particular suffer from bureaucratic controls and permissions, interference by local government officials, complex processes, elaborate paperwork, delays at customs and ports, and stoppage of goods on highways by road transport officials. These procedures impose enormous transaction costs and as a result, running a manufacturing operation has become very difficult. It is, therefore, hardly surprising that most young people shy away from starting and managing such enterprises. Modest changes such as self-certification of taxes, payment of all transport charges at departing destinations, single-day processing to set up a firm all reduce government interference and are urgently required.

India remains a laggard in terms of investment in innovation and R&D. About one percent of the GDP is spent on R&D and most of it comes from the government. Industrial policy must demand patents or proof of innovation before offering subsidies on tax and other benefits to firms. Government laboratories should have market linkages. Once the strategy for SMEs is reset, they could become the key agents of innovation in the industrial sector. The government must guarantee matching funds to all young graduates who have patents in order to commercialize their innovations into enterprises.

The slowdown in the economy will lead to restructuring of the manufacturing sector and many firms will down their shutters. The only question is whether our policies will facilitate the rise of a new manufacturing firm that is innovative, productive and flexible. This will build capabilities to make manufacturing in India the “Laboratory of the World.”

Pankaj Chandra is a Professor of Operations & Technology Management and Director of the Indian Institute of Management, Bangalore, India. Email:
chandra@iimb.ernet.in

 


India in Transition (IiT) is published by the Center for the Advanced Study of India (CASI) of the University of Pennsylvania. All viewpoints, positions, and conclusions expressed in IiT are solely those of the author(s) and not specifically those of CASI.

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