S P E C I A L R E P O R T

B U S I N E S S I N I N D I AOctober 22nd 2011

Adventuresin capitalism

Indian business.indd 1 11/10/2011 13:32

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The Economist October 22nd 2011 1

SPECIAL REPORTBUSINESS IN INDIA

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ON AUGUST 1ST India’s �nance minister, Pranab Mukherjee, gatheredthe country’s senior businesspeople for a pep-talk in New Delhi. Theevent (pictured) was notable for two reasons. First, the subject of discus-sion was the wobble in con�dence that has taken place over the pastyear. Although a mini-industry has arisen of India optimists who predictthat the country’s entrepreneurial spirit will make it an economic super-power over the next two decades, many business folk on the ground feeldisillusioned. They worry that India’s notorious red tape, graft and lackof infrastructure are �nally catching up with it. Largely unnoticed abroadand eclipsed by the rich world’s sovereign-debt crisis, the Indian econ-omy has hit a sticky patch, with investment slowing, in�ation high andgrowth expected to dip to perhaps 7%, from a peak of 10%. After two and ahalf hours, needless to say, the bosses emerged and expressed boundlessoptimism with the gru� air of men in the grip of a half-Nelson.

The second surprise, given India’s reputation as a land of red-hotstart-ups and new entrepreneurs, was the dynastic nature of those cap-tains of industry. They included Ratan Tata, the �fth-generation head ofTata Sons, a conglomerate; Anand Mahindra, the chief executive of theMahindra group, which was co-founded by his grandfather; and AnilAmbani, who inherited a chunk of the Reliance empire built by his fa-ther. The main representatives of �rst-generation entrepreneurs wereShashi Ruia, who built the Essar group with his brother and who hashanded day-to-day management to his son; and Sunil Bharti Mittal, whocontrols India’s biggest mobile-phone operator, and whose son recentlyjoined the �rm after a stint as an investment banker in London. True, notall Indian �rms are dynastic: Y.C. Deveshwar, a veteran business leader,attended in his capacity as chairman of ITC, a �rm controlled by institu-tional investors, rather than a family. But ITC has become the kind of con-glomerate that Western textbooks advise against, spanning everythingfrom stationery, cigarettes and spice-grinding to noodles and hotels.

Amid the barons and conglomerate bosses, the only man who rep-resented a recognisably contemporary Western vision of the corporationwas N.R. Narayana Murthy, the lead founder of Infosys. It is focused onone business line, computer services, which are mainly sold to rich coun-tries. And it is owned by di�use institutional shareholders, has gold-stan-

Adventures in capitalism

Indian businesses are rewriting the rules of capitalism in a

distinctive and unexpected way, says Patrick Foulis

A C K N O W L E D G M E N T S

C O N T E N T S

In addition to those mentioned and

quoted in the text, the author

wishes to thank the following people

for their help: Devendra Amin,

Pradipta Bagchi, Uday Baldota, Arun

Bhagat, Indrani Bhattacharya,

Debojyoti Chatterjee, Phiroza Choksi,

Shravani Dang, Anindya Datta, Mira

Desai, Charudatta Deshpande,

Shubhada Dharwadkar, Suprio Guha,

Sarika Kapoor Chokshi, Andrew

Lorenz, Kulsum Merchant, Jimmy

Mogal, Pankaj Mudholkar, Sachin

Mulay, Christabelle Noronha, Kirsten

Paul, Prasad Pradhan, Dr Pragnya

Ram, Mahesh Shah, Capt Kunal

Sharma and Milya Vered.

A list of sources is at

Economist.com/specialreports

An audio interview with

the author is at

Economist.com/audiovideo/specialreports

4 Family �rmsThe Bollygarchs’ magicmix

7 Inbound andoutbound dealsTheir oyster, with gritincluded

10 Innovation andcost-cuttingThe limits of frugality

11 State-controlled �rmsThe power and theglory

12 The outlook forentrepreneursLooking for the nextInfosys

13 The Indian miracle andthe futureRolls-Royces andpot-holes

2 The Economist October 22nd 2011

BUSINESS IN INDIA

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1

dard corporate governance and accounting, and in the next fouryears is expected to wave goodbye to the last of its founders stillplaying an executive role. It is a corporate fairy tale: in a singlegeneration Infosys has leapt from a start-up, founded by a hand-ful of engineers with $250, to global blue-chip company. The In-fosys vision of Indian capitalism was popularised by ThomasFriedman, an American journalist who had an epiphany afterplaying golf in Bangalore and meeting Infosys’s chief executive.Mr Friedman went on to write the 2005 bestseller �The World IsFlat�. It described an India of buzzing entrepreneurs and start-ups, turbocharged by the internet, outsourcing and global com-munications�a kind of giant Silicon Valley with worse roadsand spicier food. In the years since, perhaps re�ecting the woesof the West and the rise of China’s state-backed approach, someobservers have been less restrained, celebrating a reassuring In-dia of a billion innovators who, through a bottom-up revolution,would propel their country to prosperity.

Just as Lenin hoped Russia could skip a Marxist phase ortwo and jump from agriculture to communism, so these cheer-leaders hoped India could leap from sclerotic socialism, which

prevailed between independence in 1947 and liberalisation in1991, towards a Western form of institutionally run capitalism.But that is not how things have turned out. Infosys has just beenovertaken as India’s most valuable computer-services �rm byTCS, part of the 143-year-old Tata group. Look at India’s leading100 �rms by market value and you will not see any others like In-fosys�blue-chip, focused, di�usely owned, created in the pastthree decades and run on non-hereditary principles�bar a few�nancial �rms. And whereas Mr Friedman cited �software,

brainpower, complex algorithms, knowledge workers, call cen-tres, transmission protocols [and] breakthroughs in optical engi-neering� as the new sources of wealth, many of the latest gener-ation of Indian oligarchs made their cash from old-fashionedthings like roads, mines, energy and property. In short, India hasnot conformed to anyone’s template. It has gone its own way.

What does this new kind of capitalism look like? An im-mense, often unrecorded informal sector employs the majority

of Indians. But in terms of value added�acrude way of measuring activity that isused by economists�Indian capitalism isconcentrated. In 2007 a government sur-vey of almost 200,000 services �rms, for-mal and informal, concluded that the top0.2% of them accounted for almost 40% ofoutput, and that companies in two states,Maharashtra and Karnataka, which hostthe commercial hubs of Mumbai andBangalore, collectively accounted forabout half of output.

Next, look at the stockmarket. It isnot an ideal proxy for India Inc, but it isthe only reliable one. About 70% of its val-ue sits in the BSE 100 index of the largest�rms, the smallest of which is worth justunder a billion dollars, below which a�rm is considered a tiddler by global stan-

dards. As a group, these businesses have a return on equity thathas declined in recent years but remains solidly in the mid-teens,making Indian �rms more pro�table than many of their Asianpeers, reckons Anirudha Dutta of CLSA, a brokerage. Debt levelsare low and growth has been strong, with pro�ts rising sixfoldsince 2001 in dollar terms to $64 billion.

That makes India big, but not that big. It accounts for about3% of the world’s stockmarket value. Cheered, feared and jeeredat home, India’s giants are mere middleweights on the global

31.0 13.117.124.5 14.3

57.2Reliance Industries

50.7Coal India

49.7Oil and Natural Gas

42.6

Tata ConsultancyServices

32.5ITC

31.0Bharti Airtel

30.1NTPC

26.1

State Bankof India

23.9HDFC Bank

21.6ICICI Bank

20.8

Larsen &Toubro

20.6

HousingDevelopment

Finance

29.1Infosys

17.6Wipro

17.4

Bharat HeavyElectricals

10.8

JindalSteel

& Power

10.6

SunPharmaceutical

10.3

Mahindra&

Mahindra

10.2

TataMotors

Basic materials,utilities and energy

Technology and telecoms

Consumer andhealth careFinancials Industrials

15.5

HindustanUnilever

India’s top 20 listed firmsby market capitalisationSeptember 2011, $bn

State

Family

Diffuseowners

Foreign

Controlled by:

Sector weights in the BSE 100 index, %

Source: Bloomberg

Cheerleaders hoped India could leap from scleroticsocialism towards a Western form of institutionally runcapitalism. But that is not how things have turned out

The Economist October 22nd 2011 3

SPECIAL REPORTBUSINESS IN INDIA

2 stage. State Bank of India, India’s largest lender, is a tenth of thesize of China’s biggest, measured by pro�ts. Reliance Industries,a family-run conglomerate with a skew towards chemicals andenergy that is the subcontinent’s most valuable �rm, is only athird as big as Total of France. If all goes to plan and India’s econ-omy grows quickly it will still be a decade before its �rms beginto challenge those of the rich world and China by size. After twodecades in which sunrise industries such as mobile telecoms,media, health care and �nance have thrived, India’s distributionby sector now looks pretty conventional by global standards (seegraphic on previous page).

What makes India unusual, aside from its rapid growth, isits form of ownership. Its evolution can be crudely split intothree periods. Until 1991, when liberalisation began, Indian busi-nesses that had not been nationalised were family a�airs thatsurvived in a world of micromanagement and o�cial targets�the �licence raj�, a surreal mix of Soviet stupidity, British pedant-ry and Indian improvisation. Firms responded by branching outinto any activity where they could �nd room to breathe, whilefacing little serious competition in their main businesses. Manyenjoyed close links with the Congress Party that formed India’s�rst post-independence government and dominates the rulingcoalition today. By the time an economic crisis brought on liber-alisation in 1991, though, most business folk were utterly fed up.

The pattern of ownership in the second period, betweenliberalisation in 1991and 2003 (when the economy’s growth ratemoved up another gear) was far more turbulent, as lazy old fam-ily groups were exposed to �erce competition at home and fromabroad and the prices of everything from machines to India’scurrency were freed up. Many �rms didn’t survive. Of the largest20 listed on the stockmarket in 1990, only �ve remain in a recog-nisable form in the top 20 private �rms today, ranked by marketvalue. The big textiles houses that dominated the scene in 1990were much diminished over the next decade (although BombayDyeing is, despite its name, still in business), and some of thegrand families behind them such as the Mafatlals dropped fromthe upper ranks of capitalist clans. Indian business in its �rst de-cade of freedom, then, did destruction and creation. Indeed, asthe economy took o� in 2003 the possibility that the old, oligar-chic form of capitalism might be obliterated altogether, perhapseven to be replaced by a freewheeling approach that had morethan a whi� of America about it, seemed a sensible prediction.

Sensible, but wrong. For if an alien investor landed inMumbai today and ignored every aspect of life there other thanthe structure of the stockmarket, the closest thing would not beNew York’s bourse, but a weird mix of São Paulo, Seoul andShanghai. Some 41% of India Inc, measured by the pro�ts of the

biggest 100 �rms, sits in the hands of state-controlled companies,from big oil �rms to Coal India, with its vast empire of opencastmines, its own corporate song and 377,932 loyal workers. Blue-chip �rms controlled by institutional owners, such as ITC, and ahandful of subsidiaries of foreign �rms such as Unilever, togeth-er account for only 18% of overall pro�ts. The remainder, some41% of earnings, are made by �rms under some form of family orfounder control. This special report will include Tata Sons in thiscategory even though the present �fth-generation boss is likelyto be the last family member in charge and most of its shares areowned by family trusts that are meant to be independent.

Capindialism

Within this broadly de�ned category of family or founder�rms it is also possible to �nd examples of every kind of freshsuccess. Gautam Adani, a strapping billionaire with a habit ofwatching share prices on television as he talks, has used brawnand guile to build from scratch an empire of ports, power andcoal centred in Gujarat, a western state. In a Mumbai suburb Di-lip Shanghvi, a soft-spoken scientist, has turned Sun Pharmaceu-tical from a minnow into a global generic-drugs �rm worth $10billion. Yet the older family �rms, toughened up by 20 years ofcompetition, matured by bitter feuds and splits, and still with re-markable reserves of animal spirits, have at least held their own.

India’s economy is one of the world’s most dynamic. Someindustries, such as media and aviation, are unrecognisable fromten years ago. There has been a fair amount of turnover amongthe leading �rms. But overall, India’s form of ownership hasbarely changed over the past decade. The division of pro�tsmade by family �rms between those in their �rst, second andthird or older generations has stayed pretty constant. The newkids on the block have made gains but not won the day. Nor hasthe pro�t share of family �rms overall, of whatever vintage,changed much. The mix of state, blue-chip, foreign and familyowners has been remarkably stable.

In the past decade Indian business has not been on a jour-ney towards someone else’s economic model, whether Chinese,European or American. It has not been growing out of an imma-ture phase, or shaking o� a simpler way of doing things. Insteadit seems to have established its own equilibrium�what might becalled �capindialism��in which pro�ts are controlled not by in-stitutional shareholders but mainly by the state, or by entrepre-neurs and their descendants. Outside the state �rms, the �ddlyconglomerate is the favoured form of organisation. This specialreport will try to answer the big questions all this raises. Why hasIndian business developed in this way? Will it continue to? Canthe aspirations it has raised be met? And is this new form of capi-talism good for India�and the world? 7

1Who owns how much

Sources: Bloomberg; The Economist

Profits of top 100 Indian listed firms by type of controlling shareholder, %

Fiscal years ending March

0

20

40

60

80

100

2002 03 04 05 06 07 08 09 10 11

First-generationentrepreneurSecond generation

Third or oldergenerationState

Institutional

Foreign

2Still ahead of the pack, just

Sources: Thomson Reuters; CEIC

Return on equity, %

1997 98 99 2000 01 02 03 04 05 06 07 08 09 10 115

0

5

10

15

20

25

+

–

MSCI Emerging Asia

India (BSE 100)

4 The Economist October 22nd 2011

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TO FIND RAJEEV PIRAMAL, the 35-year-old boss of Penin-sula Land, you go down a drive in deafening Parel, an up-

and-coming business district in Mumbai that used to be the cen-tre of the textile industry. A new tower block is zooming up onone side, and nets hang overhead to guard against falling debris.Mr Piramal’s o�ce is in an old mill building whose steel pillarsare stamped with �Blackburn�, the English town where theywere forged long ago. This is a place where corporate death andrebirth is happening in real time; where derelict factories andworkers’ tenements are being demolished to make way for trad-ing �oors and media out�ts with ping-pong tables in their lobbies.

The family �rm isn’t dying in this environment, it is thriv-ing. Mr Piramal’s great-grandfather was a trader who made it bigin textiles in Bombay, as Mumbai was once known. The family’smills were clobbered in the 1980s and early 1990s, but unlikesome of Bombay’s other famous textiles clans, such as the Mafat-lals, the Piramals have not faded away. They turned to property,redeveloping their defunct industrial sites a decade ago, thentaking on others’ mill land and, most recently, evolving into amainstream developer across the country, with book equity ofsome $300m. Rajeev’s branch of the family also dabbles in engi-neering and entertainment. Another bit of the clan split o� in1981 and operates a luggage business, while yet another, whichbroke away in 2005, specialises in health care and glass. In 2010 itsold its domestic drugs operation to Abbott, an American �rm,for a staggering $3.8 billion. This year it bought a 5.5% stake in Vo-dafone Essar, a big mobile-network operator.

Adaptable, ingenious and combustible, the family �rm re-mains the backbone of India’s private sector, not an anachro-nism. �This is politically incorrect,� jokes Kumar MangalamBirla, who runs Aditya Birla, the third-biggest family businesshouse by sales, before going on to argue that the family, and thevim it brings, is an essential part of India’s economy. There is noeasy way to categorise these business houses, but vintage is oneapproach (see table). The oldest, such as Aditya Birla, Tata and

Family �rms

The Bollygarchs’ magicmix Why India’s soft state encourages family-owned

�rms and conglomerates

Bajaj, stretch back over three or more generations and are wilysurvivors. Second-generation �rms include Reliance Industries,India’s biggest private �rm, run by Mukesh Ambani, who splitfrom his brother Anil in 2005, and whose late father’s rise frompetrol-pump attendant to billionaire is the stu� of legend.

First-generation �rms include the winners from sunrise in-dustries such as telecoms and computing, which boomed in thelate 1990s and early 2000s�Bharti Airtel and HCL, a technology�rm, being two �ne examples respectively. More recently theranks of �rst-generation �rms have been swelled by the Adanigroup, big in ports and power, and GMR, an infrastructure �rmbased in Bangalore. The shift from export and consumer-facingindustries towards �rent-seeking� sectors with more governmentinvolvement is an important and, some say, worrying trend.

A �nal category is the o�shore Indian family group. The Hin-duja brothers, who run everything from Ashok Leyland, a truck-maker in India, to a Swiss bank, are partly based in London. Ve-danta, a big natural-resources out�t, shifted there in 2003. Such�rms mix Indian and foreign activities. It is tempting to includeMittal Steel, based in Europe and run by Lakshmi Mittal, in thisgroup. But he is better regarded as an escapee from India whomade his fortune only after leaving the country as a young man.

Doing it vertically and horizontally

Most of these groups have two shared characteristics. First,complexity. Although many have simpli�ed since 1990, most arestill �ddly, with intricate chains of holding companies and sub-sidiaries. Second, they are conglomerates, often with one or twocore activities and a long and growing tail of others. The holdingchains are relatively easy to explain and are common in othercountries such as Italy and Brazil. A cascade of companies meansoutside capital can be brought in at multiple levels without weak-ening family control. In India complexity is also sometimes a re-sponse to family spats, with rivals each given a distinct sphere ofin�uence. India’s regulators help, too; they talk a good gameabout corporate governance but do not require top-notch ac-counting and let �rms build stakes in others without buying outall minority shareholders. K.V. Kamath, the chairman of Infosysand of ICICI, a bank, believes governance will improve. �Compa-nies will voluntarily change,� he says. Others are less optimistic.Meanwhile, the Reserve Bank of India, the central bank, frownsupon using bank loans to fund takeovers, so they rarely happen.

The causes of the complexity, then, are understandable. It isIndia’s love of conglomerates that is the mystery. Some blame his-tory: before independence in 1947, British companies often oper-

Top dogs

Sources: Companies; The Economist *Year ending March †Estimate

India’s major private business houses

3

Name 2011* sales, $bn Controlled by Generation Comment

Tata group 84 Tata family trusts 5th Defies categorisation. A firm or a federation? Does control sit with independent trusts, outsiders or the boss?

Reliance Industries 58 Mukesh Ambani 2nd Built on dad’s epic tale of rags to riches, big in energy and chemicals. Strongest balance-sheet in India

Aditya Birla 35 KM Birla 4th An early mover in professionalising, going abroad and doing deals. Metals, textiles, cement and mobile phones

Hinduja 25 Hinduja brothers 2nd HQ moved from Mumbai to Iran and now Europe. Truckmaker Ashok Leyland and Gulf Oil are flagship firms

Essar 17 Ruia brothers 1st Active in steel, ports, shipping and energy. Essar Energy arm is London-listed and leads expansion abroad

OP Jindal 14 Jindal family 2nd Steel and power. Four brothers each have their own subsidiaries. Unclear if whole runs as an integrated entity

Mahindra 13 Mahindra family 3rd Had a second wind in the past decade. Known for tractors and SUVs, but stretches to finance and hotels

Bharti 12 Sunil Mittal 1st Biggest mobile firm. Diversifying into retail, TV and finance. Pricey African deal will test its global credentials

Vedanta 11 Anil Agarwal 1st London-listed natural-resources group, tilting back to India with plan to buy Cairn Energy’s Indian arm

Reliance Group 9† Anil Ambani 2nd Younger Ambani split off in 2005, taking capital-intensive power, infrastructure and mobile. Under pressure

Wipro 7 Azim Premji 2nd Azim Premji turned the family vegetable-oil maker into a tech giant. Had a tricky year as it restructures

The Economist October 22nd 2011 5

SPECIAL REPORTBUSINESS IN INDIA

2 ated with a local managing agent who had his �ngers in lots ofpies. Alternatively, during the socialist era between 1947 and 1991,Indian �rms faced claustrophobic restrictions from the state andtended to expand in any direction where they could get air. An-other explanation is cultural. Taking a sample of 16 of India’s bighouses, nine came originally from the Marwari and Bania com-munities, famous for their trading nous. Perhaps these culturalroots come with a preference for how to organise �rms. Even taxmight be important: one baron says that capital controls make ithard to get family money abroad legally. If it has to stay at home,better to put money into a new business than a bank accountthat returns less than in�ation.

Yet the best explanation is India’s soft state. Courts can takeyears to make their minds up, so contracts are hard to enforce. In-frastructure is often poor, supply chains tricky, red tape a hazard,and markets for people, materials and �nished goods unreliable.Tarun Khanna and Krishna Palepu of Harvard Business Schoolcoined this idea in a 1997 paper. In these circumstances it makessense to do things yourself. Such vertical integration even hap-pens at Infosys, which generates much of its own electricity andtops up the education of new recruits. The Adani group willsoon mine coal in Australia that is delivered to its own port inGujarat and used partly to �re its own power stations.

Even Bollywood does vertical integration. In Film City, aleafy area north of Mumbai reserved for movie sets, Anil Arjunruns a new facility that will o�er �lm-makers everything fromsets and camera equipment to editing services. Outside India,his �rm specialises: its Los Angeles arm helped ensure the 3D im-ages in �Avatar� were properly aligned. But inside India it doesthe Full Monty, even owning cinemas. The company in questionis Reliance MediaWorks, and it exempli�es a second kind of wayof spreading out a conglomerate: horizontally, across unrelatedindustries. It is part of the Reliance Group, run by Anil Ambaniand active in power, �nance and telecoms, among other things.The bene�ts of this second kind of expansion may seem less ob-vious, but it is still wildly popular, suggesting that synergies �owfrom being part of a big group in terms of �nancial muscle, man-agerial talent, brand, technology and in�uence with o�cials.

A test of the soft-state theory is whether �rms that are not infamily hands also diversify vertically and horizontally. Very of-ten they do. A good example is Larsen & Toubro (L&T), an engi-neering �rm founded by two Danes in Bombay in 1938 which iswidely viewed as one of India’s best companies. Although it hasslimmed down in some areas, its activities are still very diverse,from making submarines to building roads. Physical assets com-prise a small share of its balance-sheet, with minority invest-ments, loans made to customers and working-capital balancesmaking up the lion’s share of its assets. This suggests it is in part a�nancial �rm now, and that it uses its muscle to compensate forthe lack of bank funding and bond-market �nancing for infra-structure investments. This year L&T �oated a �nance business,and it is considering applying for a banking licence. India’s fam-ily bosses would applaud.

Family �rms dominate the private sector in much of Asiaand Latin America. But unlike in South Korea, where the chaebol

act in close concert with politicians, India’s �rms only engagewith the state opportunistically�it is their enemy as well as occa-sional partner. Nor should India’s conglomerates, particularlyfamily-owned ones, be slammed for rigging markets, as they aresaid to in other countries such as Mexico and Israel. India’s capi-talism doesn’t really work that way. The family houses go to warwith each other and face new entrants: in industries such as re-tailing, power and mobile telecoms, pro�tability is poor as a re-sult. In India the institution of the family �rm is entrenched, butthere is constant turnover. Who is on top at any point �never

stays the same�, says Adi Godrej, the head of the Godrej group.The numbers back this up. For family �rms in the top 100, overallreturns on equity look similar to those of state-owned and insti-tutionally owned �rms, indicating that family �rms are not mak-ing supernormal pro�ts. This year an IMF study concluded thatalthough such �rms were as dominant as ever and the numberof new entrants had fallen, competition was still lively.

India’s family capitalism is dynamic and its patriarchs arethe only people prepared to put billions of dollars at risk to buildthe new India. It is, of course, possible to �nd other objections,from the crowding out of new entrepreneurs to inequality. But itis also worth considering whether India’s family �rms will �zzleout of their own accord. In other countries family conglomeratesand corporate federations have been merely a phase of capital-ism, and have declined on their own. This can happen in threeways. They can become �abby and lossmaking, as in the case ofJapan’s keiretsu. The need to raise outside capital to �nancegrowth can slowly dilute the family’s stake to insigni�cance. Orthey can run out of credible heirs. The last two factors are com-mon in America and Europe, where Hilton, Cadbury and othershave evolved into companies run for institutional investors.

Will India’s family �rms fade of their own accord, too? To aWestern eye, Tata is far along this path. It is bewilderingly com-plex, with at least 20 operating divisions, a couple of them heavi-

Reliance MediaWorks knows all about family dramas

1

6 The Economist October 22nd 2011

BUSINESS IN INDIA

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2 ly lossmaking. After big foreign takeovers such as that of JaguarLand Rover, a carmaker, and Corus, a steel �rm, it is capital-hun-gry. And when Ratan Tata, its patriarch, who has no children, re-tires at the end of 2012, there is no obvious family heir�the �rmhas been trying to �nd an outsider to �ll his shoes. The mainholding company’s shares are controlled by family trusts andPallonji Mistry, a construction magnate. Those trusts are admit-tedly likely to retain Mr Tata as chairman even after he departsfrom Tata itself, but are supposed to operate independently. Andalready investors view the credit risk of Tata’s subsidiaries di�er-ently, suggesting they are not convinced it is an integrated whole.Tata, then, might seem so disparate and so close to losing anyfamily connection that it is ripe for a revolution.

The view from Bombay House, Tata’s headquarters inMumbai, is di�erent. The end of family in�uence need not implya change in strategy, the �rm argues. Its biggest problem is to keepa sense of direction once Mr Tata departs�some outsiders say itnow lacks much of a common culture. Its �nancial structuredoes not compel it to change, either. Take its overall pro�tability.Like all Indian groups, Tata says it does not run the empire bymonitoring its totted-up share of all of the pro�ts or losses of ev-ery subsidiary, as a Western conglomerate might. Yet unlike

most, it does measure this, under an initiative by Ishaat Hussain,the �nance director of Tata Sons, the holding company. So al-though some �aky businesses do shelter under the Tata umbrel-la, �gures shown to The Economist suggest that Tata’s overallpro�tability has recovered after a slump due to its acquisitionsplurge (see chart 4). Nor is the group short of resources. Its highpro�ts help fund growth, and Tata Sons could raise almost $12 bil-lion by reducing its stake in TCS, its technology arm, from 74% to51%. Mr Hussain says the �rm aims to raise its stakes in group �rmswhere it owns less than 51%, not make them more independent.

Across Indian family groups there are pockets of pressure.Anil Ambani’s Reliance Group needs to raise equity. And in the

infrastructure industry, heavy upfront investment and projectdelays are leading to �nancial engineering. Family groups likeGMR, which built Delhi’s wonderful new airport, and HCC,which built the Sea Link bridge, Mumbai’s only showpiece de-velopment, are experimenting with raising equity at multiplelevels of their business, creating structures that look �ddly andcould in time prove fragile. But the �nances of India’s familygroups as a whole do not contain the seeds of their own destruc-tion. Reliance Industries is both pro�table and has a rock-solidbalance-sheet. The more complex Aditya Birla group, to the ex-tent one can tell from the outside, is more indebted and scoresless well on its return on equity, but is in serviceable condition.Some, such as Mahindra, refuse to tolerate sloppy and lossmak-ing divisions. Bharat Doshi, the group’s chief �nancial o�cer,sounds as if he could work for GE when he says all units musthave a return above their cost of capital.

And when family groups do sell out, they often reinvest,rather than retiring to nightclubs in San Tropez. In 2008 the Singhbrothers sold Ranbaxy, a third-generation pharmaceutical �rm,to Daiichi Sankyo of Japan for $4.6 billion. They have ploughedalmost $1 billion of their proceeds into their remaining health-care business, Fortis, and Religare Capital, an emerging-marketsinvestment bank they are bravely trying to build from scratch.

Leave those kids alone

The third threat, succession, looms the largest. In Indiathere is a lot of talk that the next generation of hereditary capital-ists, after studying abroad (usually in America), might be moreinterested in becoming rock-climbers and rappers than industri-alists. But in truth the lure of the family is still strong. Those bar-ons with young children tend to say that they can do whateverthey like. But at almost all family groups where the children areadults, they have joined the �rm. Kids are expected to work theirway up, like their dads. Gautam Adani, the ports-and-power mo-gul, says of his eldest son: �For ten years he will go through theentire �rm�we are grooming him.

The vulnerability this creates is twofold. First, there is theproblem of rows as succession takes place. To avoid this, the cur-rent vogue is for family constitutions, often drawn up by expen-sive lawyers in London. These show a touching faith in the pow-

er of a contract to overcome siblingrivalry. Then there is the potential pro-blem of credibility. Although India’s fam-ily bosses are generally an impressive andengaged bunch, some of the current gen-eration can seem semi-detached. In an in-terview with The Economist in May 2011,Naveen Jindal, a member of parliamentand head of a steel �rm worth $9 billionthat is the biggest branch of the OP JindalGroup, seemed hazy about and reluctantto discuss the details of his �rm.

The biggest long-term risk for Indianfamily �rms is not competition probes, rickety �nances or lack-lustre pro�ts. It is that the kids aren’t good enough. One wide-spread hope among families is a fudge, in which the next gener-ation, even if uninvolved directly in the �rm, still call the shotsbut employ professional managers to run things day to day. Thisseems unlikely to work: what chief executive would accept stra-tegic direction from a chairman with no experience? And even ifthe family retains control, the amount of money outside inves-tors have put into Indian �rms means they may resist appoint-ments based on surnames. To stay in control, Indian families willhave to stay involved and be competent, particularly as their�rms grow larger, more complex and more global. 7

In other countries family conglomerates have beenmerely a phase of capitalism, and have declined of theirown accord. Will that happen in India?

4The league table that really matters

Sources: Bloomberg; The Economist estimates

Estimated return on equity of big business groups

Fiscal years ending March

0

10

20

30

2008 09 10 11

Tata Sons

Reliance Industries(M. Ambani)

Reliance Group(A. Ambani)

Aditya Birla*

OP Jindal Mahindra & Mahindra

*Excludes derivatives gains and losses at Novelis

The Economist October 22nd 2011 7

SPECIAL REPORTBUSINESS IN INDIA

1

IN THE SOUTHERN state of Kerala earlier this year a trea-sure was discovered in a temple. Hidden in secret vaults for

hundreds of years, it is thought to be worth many billions of dol-lars and includes coins from the Roman empire, Venetian ducats,16th-century Portuguese money, 17th-century Dutch East IndiaCompany currency and even the odd nugget or two from Napo-leonic France. �The �nd is like an economic history of India un-folding,� says Gurcharan Das, a writer and former boss of Proc-ter & Gamble in India. For most of its history the subcontinentwas open to trade and the outside world. The insularity and pro-tectionism of the 1947-91period was, he says, �an aberration�.

When it comes to trade, India is still not as open as China.Exports, and not just software and outsourcing, are howevergrowing fast and there are signs that India is gaining traction as amanufacturing centre. Bajaj Auto, a family �rm, for example, ex-ported almost 1.2m motorbikes and three-wheelers in the year toMarch 2011, with about half going to Africa and the Middle East.For all that, though, most Indian �rms are making their mark notby trying to be the workshop of the world, but by aspiring to bemultinationals: active, in control and physically present in lots ofcountries, doing everything from development and manufactur-ing to branding and distribution. They are doing all this far earli-er than �rms in other emerging countries would dare.

Indian bosses, a sophisticated and worldly bunch, have ahuge cultural head start, as anyone who has witnessed a Chi-nese state-owned �rm trying to charm the outside world can tes-tify. They are sometimes said to have other advantages, too; Indi-an �rms can handle diverse workforces, for example, since theyalready do at home. The most breathless strain of this argumentis that if you can make money in India you can make it any-where. Indian �rms, it follows, are destined to rule the world.

That last claim is silly. Indian �rms also face formidable dis-advantages. One is their size: they are middleweights by interna-tional standards. Their �ddly holding chains make it hard forthem to pay for things by issuing shares, and their cash�ows canbe thinly spread across many subsidiaries. Raising debt in Indiato buy things abroad is expensive, withbase interest rates approaching 9%, anddi�cult because the central bank frownsupon it. Indian �rms raising funds abroadare hobbled by the country’s poor creditrating. India does have large foreign-ex-change reserves, but these are not recy-cled as cheap foreign-currency loans tofund corporate adventures, as they are inChina. T.C.A. Ranganathan, the boss ofExport-Import Bank of India, a state bodyaimed at �nancing trade, says it simplydoes not have the same risk appetite as itsChinese equivalents.

These factors help explain why the�rst wave of takeovers abroad by Indian�rms, between 2004 and 2008, took sucha peculiar form (see table). A product ofthe debt bubble, they were leveraged buy-

outs in all but name, from Tata’s trio of deals to those undertakenby Hindalco (part of the Aditya Birla Group) and Suzlon, a wind-turbine �rm. These �rms used money borrowed largely fromWestern banks and money markets, in some cases secured onlyagainst their targets’ cash�ows. As the crash in the West began,their re�nancing options dried up and the target �rms’ pro�tsslumped in most cases.

Things looked pretty bleak. Ishaat Hussain, the �nance di-rector of Tata Sons, recalls the group being battered and putting aprogramme in place to raise spare cash. Tata Motors’ vice-chair-man, Ravi Kant, says the combination of a deal and a �nancialcrisis �put great stress� on the carmaker. At one point it asked theBritish government for state aid. Smaller �rms that had followedthe leveraged buy-out path got whacked, too. Havells, an elec-tronics and consumer-goods out�t, bought Sylvania, headquar-tered in Frankfurt, in 2007, but by 2008 its London bankersthreatened to pull the plug. Everything was on the line, recallsAnil Gupta, its joint managing director: �The family’s reputation,our business’s reputation and our personal reputations.�

His �rm toughed it out and emerged stronger. Tata and Ad-itya Birla did too, though their subsidiaries Tata Motors and Nov-elis are still viewed as risky bets by debt investors. Suzlon, once adarling of investors, had to restructure part of its debt. Mere sur-vival, however, is not the point of takeovers. The real test is creat-ing value. Tata has done very well on JLR but most analysts reck-on it overpaid on its larger deal for Corus. Last year Novelis failedto cover its cost of capital, though Mr Birla is optimistic. From ashareholder’s perspective Suzlon has been a disaster. Indianbosses tend to argue that they are building for the long term andhint that return on capital is for wimps and nitpickers. Many In-dians are also intensely patriotic about these deals. But at somepoint a more sober judgment must be struck.

The leveraged buy-out approach may already be �zzlingbecause the generous debt terms that it relied on are no longeravailable. Mega-takeovers are likely to be the preserve of big,cash-generative groups with simple structures. One such �rm,Reliance Industries, is on the prowl, though its proprietor, Mu-kesh Ambani, is thought to be impressively stingy about deals.Bharti Airtel took the leap in 2010, paying $11 billion for Zain, anAfrican mobile operator. The acquisition makes strategic sensebut unfortunately looks like another case of overpayment, par-ticularly because Zain’s pro�ts have since disappointed.

For the many other Indian �rms without giant resourcesand a taste for Russian roulette, a more nuanced approach todealmaking abroad beckons. In a continuation of the vertical-in-tegration habit, Indian �rms have spent billions buying up coal

Inbound and outbound deals

Their oyster, with gritincluded

Cross-border deals involving Indian �rms have been

more famous than pro�table

Cross-border, cross shareholders

Sources: Dealogic; Bloomberg; Company reports *Aditya Birla †Adani Group

Largest Indian cross-border deals, $bn (year)

5

Buyer Target

Vodafone: 18.6 (2007) A Hutchison TelecomOverpaid. Writedown after price war and tax spat

BP: 7.2 (2011) A Stakes in RelianceWill BP’s help increase output? Industries’ offshore fields

Daiichi Sankyo: 4.6 (2008) A Ranbaxy LabsFiasco. Shares worth less than half purchase price

Vedanta: 4.5 (2011) A Cairn Energy IndiaOil deal bogged down in red tape for a year

Abbott Labs: 3.7 (2010) A Piramal HealthcareBold strategic move, scary valuation

NTT DoCoMo: 2.7 (2008) A Stake in Tata’s mobileTerms unclear, but Tata’s mobile arm is struggling business

Buyer Target

Tata Steel: 13.0 (2006) A CorusImpressive ambition, bad timing. Paid too much

Bharti Airtel: 10.7 (2010) A Zain AfricaEarly days but looks pricey. Zain has since stumbled

Hindalco*: 5.7 (2007) A NovelisRecovery under way but yet to cover cost of capital

ONGC: 2.6 (2008) A Imperial EnergyProduction has missed targets since the deal

Tata Motors: 2.3 (2008) A Jaguar Land RoverGreat deal, has confounded the critics

Abbot Point: 2.0 (2011) A Mundra Port†

Secures coal supply with export hub in Australia

I N D I AFOREIGN FOREIGNOUTBOUND AA INBOUND

8 The Economist October 22nd 2011

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2

1

resources in Australia and Indonesia. They may have to competeagainst undisciplined Chinese buyers and there are worriesabout political risk in Indonesia, but in the main these dealsmake sense given the shortage of domestic production.

Another emerging trend is that of the �pocket multina-tional�, which uses a series of smaller bolt-on acquisitions tobuild up its presence abroad. These can provide access to newproducts, technologies and markets, but without an all-or-noth-ing gamble. Crompton Greaves, part of the Avantha group con-trolled by Gautam Thapar, underwent a strategic review in2001-02. �The results were sobering,� he says. In response itmade a succession of foreign deals, mainly in Europe, in its areaof electronics and engineering, with the main aim of gainingknow-how and better products. With a total outlay of some$250m these deals made a decent return on capital last year,though trading has since been hit by the euro-zone crisis.

Godrej, a family conglomerate whose biggest line is con-sumer products, is another exemplar of this approach. Althoughnot closed to the idea of a large transformational acquisition, AdiGodrej, its boss, says the �rm was too disciplined during theboom. Instead of betting the farm it spent about $1billion on a se-ries of small purchases in niche areas, such as an Indonesian�rm that makes household products including insecticides andair-fresheners, and a South African maker of hair products. MrGodrej says it is taking a hands-o� approach to managing thesebusinesses and that the acquisitions have all made fair returns.

In most cases the aim of such deals is to marry the savvy In-dian approach to things like working capital with the acquired�rms’ managers, technology and products. The danger is that theacquiring �rms are spreading themselves too thinly, creating theoverheads of a global company without the correspondingsales. Still, it is an approach that is gaining popularity, with Info-sys recently emphasising that it would consider bolt-on deals.The technology �rm also provides a good example of a third in-ternational expansion strategy, that of going abroad without

deals, but simply starting new operations in other countries. In-fosys now has quite a big operation in China, for example. S. Go-palakrishnan, its chief executive, says it has been successful in re-cruiting Chinese talent and has done well at winning businessfrom the Chinese subsidiaries of multinational clients. But it isstill hard to sell to Chinese �rms themselves, he says.

History suggests that building a multinational bit by bit andeschewing giant, high-risk deals is the best way to create a dura-ble �rm without wasting money. But it takes time, and India Inchas been in a terrible hurry. With �nancing conditions nowtougher and some hard lessons learned from the �rst round ofIndian takeovers, a more measured approach is likely in future.Just the kind of approach, in fact, that mature multinationalsfrom the rich world, with decades of experience under theirbelts and world-class advisers, take when viewing new marketslike India, right? Not quite. Foreign �rms that have expanded intoIndia have had their share of problems, too.

A land of milk and honey

R.C. Bhargava can still remember the day the Maruti Suzukifactory in Delhi started churning out small cars in 1983. To theamazement of the newly hired Indian workers, the Japanese su-pervisor said the plant had to be spotless �rst and, picking up amop, got to work. �We decided from the start that we had to com-pare ourselves with the best in the world,� Mr Bhargava says.That included tea breaks exactly seven and a half minutes long.Today he is chairman and Maruti Suzuki is one of India’s mostsuccessful foreign-controlled �rms, with about half a billion dol-lars of pro�ts last year. Still, during 2011 it has su�ered a wave ofstrikes in its factories. Even three decades on, the going isn’t easy.

If India is, as the cliché goes, a land of contrasts, then thebiggest may be that between the bosses of �rms the world overwho are crazy about India, and their sta� on the ground, whohave often become professional eye-rollers. Corruption, sloppystandards, a lack of decent sta� and red tape are the main gripes.

Made in India

The Economist October 22nd 2011 9

SPECIAL REPORTBUSINESS IN INDIA

Many say Indian business culture, while beguiling, is less acces-sible that it �rst seems. Hierarchies can be rigid. And deals getdone through informal networks. For all that, however, theirbosses at home are often mustard keen, tantalised by projectionsthat show India is too big to ignore, with the world’s biggest andyoungest pool of labour and a growing middle class.

Tapping into the �rst attribute, India’s labour force, has sofar mainly been the preserve of the technology industry. Follow-ing the lead of India’s outsourcing �rms, IBM, for example, hasgradually built up a workforce of over 100,000 in India, a bigchunk of whom serve its clients abroad. But beyond outsourc-ing, using India as an export base tends to be hard work indeed.Capital-intensive projects are formidably tricky to get started.Posco, a South Korean steel �rm, announced plans for a $12 bil-lion investment in a factory in Orissa, an eastern state, in 2005,aimed both at meeting domestic demand and producing for ex-port. Today work has yet to begin and the plan is still in limbo.The long squabble seems to have involved every part of India’sgovernment and judicial apparatus.

Carmakers are the great exception, but they come with atwist. Maruti exports just over a tenth of its production, mainlyto Europe. Hyundai, a South Korean �rm and the biggest export-er by volume, sells a �fth of its production abroad, says ArvindSaxena, a director of the Indian arm. Clusters of expertise exist inthe states of Tamil Nadu and more recently Gujarat, where mostcar investments now tend to go, thanks to welcoming local o�-cials. Foreign car �rms source almost all their components local-ly. Hyundai India led the way for 70-odd Korean suppliers whohave invested some $700m in facilities around its plants nearChennai. The level of research and development by foreign car�rms in India is still puny, but in time that should come too.

What India does not seem to give foreign �rms is a clear-cutcost arbitrage over other places in the world, despite its vast andcheap labour force. Other inputs such as electricity can be costlyand unreliable. Tricky logistics also make a di�erence. To get its�nished cars to Chennai’s port, Hyundai has to pack them ontotrucks that rumble through the city centre every night during thesmall hours. It reckons its Indian factories make vehicles at a sim-ilar price to its plant in Turkey, once trade duties are included.

For foreign carmakers it only makes sense to export from

India products that you are also sellingthere, to piggyback o� the economies ofscale that India’s big domestic marketcreates. Small cars are a great example.The hitch is that the products made in In-dia have to be good enough and similarenough to be attractive to the rest of theworld. That isn’t always a given.

�I remember sitting in a remote vil-lage with a man who was tasting cola forthe �rst time. He spat it out and said, ‘thistastes like medicine’,� recalls Ashok Ku-rien, then a marketing guru and now anentrepreneur. �I realised you couldn’t sella cola in this country on taste.� His sol-ution was an advertising campaign forThums Up, a local cola, under the slogan

�Taste the Thunder�, that tapped into the average Indian’s fearsand yearnings as the economy opened up in the early 1990s. Itwas so successful that The Coca-Cola Company eventuallybought the drinksmaker and tried to replace the local brand withits own global one. The result was an outcry, and the American�rm had to backtrack. Today Thums Up, owned by Coca-Cola, isstill in rude health, and keeping dentists busy.

If manufacturing in India is hard for foreigners, building acustomer-facing business is no walk in the park either. India hasbeen a success story for Nokia, Finland’s handset giant, and re-mains its second-biggest market and a big manufacturing base.But sales there have declined since 2008, paradoxically re�ectingboth its lack of high-end devices to rival the BlackBerry and theiPhone, and its lack of low-end ones, such as phones with dualSIM-card slots that penny-pinchers use to surf between net-works. To compete in India you need one eye on the world andanother on the street.

Ask a street vendor for a �Cadbury� and you’ll be given achocolate bar. That’s real distribution and branding power, but ithas taken a long time to build. The confectionery �rm (originallyBritish and bought by America’s Kraft in 2010) has been in Indiasince 1948. Its local bosses are Indian. It belongs to a select group,including Maruti Suzuki, of �rms that have been in India for the

long haul, mainly employ locals andseem to have developed deep competi-tive strengths. Many have listed local sub-sidiaries. Siemens, Germany’s industrialgiant, has been present in India for almosta century and now makes nearly $3 bil-lion of sales there. It will soon employfour foreigners for every 1,000 locals.

Hindustan Unilever, the local o�-shoot of the consumer-goods giant,makes half a billion dollars of pro�t ayear and is one of the most prestigiousemployers. It takes reinvention seriously.�We need to innovate constantly,� says itsboss, Nitin Paranjpe. �If we obsessedabout minimising risk we’d do nothing.�The largely indigenised foreign �rmprospers in banking too, with India’s big-gest foreign lenders�Citigroup, HSBC andStandard Chartered�having pedigreethere. For all these �rms their Indian unitshave gone from being backwaters togrowth engines for their parent compa-nies and sources of talent. Eventuallysome of these �rms will be run by Indi-

6Two-way trade

Source: Dealogic *Year to September 23rd

Cross-border Indian merger & acquisition deals, $bn

0

5

10

15

20

25

30

2000 01 02 03 04 05 06 07 08 09 10 11*

OutboundInbound

For foreign �rms, building a customer-facing business isno walk in the park. To compete in India you need oneeye on the world and another on the street

2

1

10 The Economist October 22nd 2011

BUSINESS IN INDIA

SPECIAL REPORT

ans who earned their spurs in the subcon-tinent�so far, most of the handful of Indi-ans who’ve made it to the top of global�rms emigrated from the mother countrywhen they were fairly young.

That success in India just takes timeis not a message other foreign �rms like tohear, though. Many have gone for theblunderbuss approach, with big upfrontinvestments in distribution to try to winmarket share quickly. This often getsmessy. More than ten foreign life-insur-ance �rms have rushed into India, allwith local partners. At their peak, beforethe 2008 crisis, they employed armies ofagents to sell savings products, often un-pro�tably, sometimes illegally. The indus-try has since shrunk and been clobberedby regulators, and some foreigners are ex-pected to exit. It was a �mindless chase forthe top line,� says one boss, �a completelyreckless expansion�. Chinese �rms havetheir own kind of land grab. ShanghaiElectric has won big contracts to buildpower stations in India, aided by a bigslug of subsidised vendor-�nancing fromstate-backed banks to the Indian buyers.

Gently does it

For those who just can’t wait, theonly real option to achieve immediatescale in India is the takeover. But sincemost assets are in hot demand, the resultsof foreign deals in India have been i�y.Vodafone has already written down itspurchase of a controlling stake in India’ssecond-biggest mobile �rm after a pricewar, a legal tangle with its India partnerand an unforeseen tax claim by the gov-ernment. Japan’s Daiichi Sankyo boughta controlling stake in Ranbaxy, a generic-drugs company, in 2008 which it wrotedown heavily as it ran into glitches withAmerican regulators. And last year Ab-bott, an American health-care group, wonan auction for Piramal’s Indian drugsunit, which came with manufacturing fa-cilities and a local sales force. But the priceof $3.7 billion, or over seven times the tar-get’s sales, suggests that the Americanbosses forgot to take their medication.

Abbott aside, though, the period ofcross-border deals from and to India hasgone beyond the euphoric stage, re�ect-ing the wobble in India’s economy, con-cerns about corruption and the deep troubles of the rich world.Both foreign �rms keen on India and Indian �rms keen to goabroad must show more discipline. This is not just about price�one executive working for a global investigation �rm says West-ern buyers, worried about graft, are �nding out more aboutwhom they are doing business with in India. And with little in-house market intelligence about far-o� countries, Indian �rmsneed to be sure they aren’t buying lemons. Giant trophy take-overs are likely to be pursued only by the biggest �rms. For theothers, a wave of smaller and probably more enriching deals

and forays awaits. It takes longer to build champions this way,but the end results will be stronger.

One thing is fairly clear. The shadiest and worst bits of theeconomy, including natural resources and infrastructure, are no-tably bereft of outsiders. Where they have been allowed in, for-eign �rms’ enthusiasm for India, and their open cheque books,have brought bene�ts. They have usually raised standards andcut prices through competition. But the power of competitioncan of course be unleashed in India in other ways, too. Howabout less government and more entrepreneurs? 7

THE MOST IMPORTANT event in Indianbusiness in 2011may have been an out-burst on September 6th by Sunil Mittal, theboss of Bharti Airtel, the mobile-phoneoperator. India’s telecoms industry isadmired the world over for the innovativeway in which it has slashed prices and putphones into the hands of even the verypoorest. Today there are some 600m activesubscribers in India, many of them in thecountryside. But Mr Mittal said the extracost of servicing rural customers, and theirlow usage levels, had made things unprof-itable. Prices are now expected to go upacross the industry, after two decades ofdecline. India’s low-cost telecoms revolu-tion has, it seems, reached its limit.

Indian �rms have made much of theirability to serve the poor masses at the�bottom of the pyramid�. Along with cheapphones, other celebrated examples in-clude one-rupee sachets of shampoo andclever schemes to get around the lack ofbank accounts. This re�ects raw commer-cial instinct, but also serves an ideologicalpurpose by showing that capitalism inIndia is not just for the middle classes. It ispolitic for Indian bosses to talk up theirability to invent things that all can a�ord.

Whether their �rms pro�t as a resultis less clear. Mobile phones are not the only�eld where the limits of frugality are beingreached. Tata Motors’ Nano, a $3,000 car,has been a �op so far. Some blame Tata’smarketing, but other carmakers say theycannot achieve such a low price withoutcompromising on quality, and that custom-ers are wary. In air travel, insurance,consumer �nance and satellite TV, compa-nies have cut prices to build their customerbases over the past �ve years but could notreduce costs enough to compensate, and

compromised on quality. As in telecoms,this is likely to lead to price rises and theexit of the weakest �rms.

Today perhaps 17% of India’s pop-ulation has half of its spending power,according to the Asian Development Bank.Over time the growing urbanised middleclass, who are getting richer fast, willbecome relatively more important forpro�ts. Margins for these customers arelikely to be higher because the cost ofdistributing products in cities is lower. Theboss of one large consumer-goods �rm says,in private, that today his company makestwo-thirds of its money from the poor andlower middle classes, but adds it is �notenough� to focus on them since �the por-tion of upper middle class will becomesubstantially more important�. He is tiltinghis products accordingly. Consumer-goods�rms are often keen to move away fromcheap products, where Chinese rivals posethe greatest threat.

One proxy for the di�erence in pro�t-ability between the urban rich and the ruralpoor is the price paid for mobile-telecomsspectrum. In the 2010 auctions for 3G tele-coms licences, operators bid ten times morefor a slice of the airwaves in a�uent Delhi,with 18m people, than in east Uttar Pra-desh, with 120m people. Similarly, India isabout to auction o� FM radio spectrum andthe competition is expected to be �ercestfor the big cities, says N. Subramanian, thechief �nancial o�cer of Radio Mirchi, a bigplayer today.

That is not to say that selling to thepoor masses, and inventing ways to cutprices in order to appeal to them, is notvital. It is, both from a moral standpointand because India’s stability depends on it.But the big pro�ts lie elsewhere.

The limits of frugality

Making things cheaper is not the same thing as making pro�ts

2

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SPECIAL REPORTBUSINESS IN INDIA

IF YOU SIT in many places in India, whether in the o�ce ofthe boss of Infosys in Bangalore or in a suburban home,

your host may clutch a remote control and appear anxious. Youare not the cause of this distress. Your host is waiting for a powercut, after which the remote will be used to switch the air condi-tioning back on. Power, more than any other industry, capturesthe prevalence of the state in Indian business�and the harm itcan do. Private capital has poured into building power stations,but most other bits of the supply chain are in the hands of thestate. Often this set-up fails to deliver.

When people think of state capitalism, China springs tomind, with its giant and opaque government-controlled �rms.But India, more cuddly and less competent, is not too dissimilar.Some 40% of the pro�ts of its 100 biggest listed �rms come fromstate-controlled ones. In �nance, energy and natural resources,they control at least two-thirds of production. Most were partial-ly privatised over the past two decades, letting in a small propor-tion of outside shareholders. The latest example was Coal India,the biggest producer of India’s main fuel. It was listed in 2010.

Over time, the zeal to sell big-enough chunks of these �rmsto enable them to become more independent has dissipated. Buttoday’s halfway house is not all that bad. In aggregate, the 24state out�ts in the top 100 generated a 17% return on equity last �-nancial year, on a par with the private sector, and pro�ts almostdoubled in the past �ve years. Privatisation has made some ofthem more e�cient. Bharat Heavy Electricals, which makes kitfor power stations, holds its own against Chinese competitors.And State Bank of India (SBI) is as tech-savvy as its private rivals.

Even if India doesn’t have the stomach for full privatisa-tion, it is letting in the private sector in other, more subtle ways. Acreeping retreat of the state has taken place in many industriesthanks to competition. Thus two of India’s most successful in-dustries, air travel and telecoms, are dominated by private com-panies, even though the original state monopolists remain un-der government control. Public-private partnerships are alsocommon on big infrastructure projects. You might conclude thatIndia, like China, has found its own equilibrium between thestate and market forces. But that view is premature. Public-priv-ate partnerships are all the rage, but more e�ort must be made toensure the private bit of them gets a reasonable return. GMR, theinfrastructure �rm that built and part-operates Delhi’s new air-port, is losing money on the project. Its boss, G.M. Rao, says he is�very con�dent� that a settlement will be reached allowing it toraise tari�s and extend its charges. But more clarity will be need-ed to attract private money for future projects of this kind.

The big listed �rms, meanwhile, are subject to meddling.Managers are appointed by the state. The energy companies areforced by the government to subsidise the costs of some kinds offuel, to the tune of billions of dollars, by smoothing retail prices.Coal India’s allocations of production seem to be decided at thehighest level of government. And SBI, although it denies it furi-ously, loaned heavily and patriotically during 2008-09 to o�set aslump in credit from private banks. In 2011 it has booked bigwrite-o�s and had its credit rating downgraded as it digests thebinge. A big chunk of the economy is in e�ect run by political �at.

Allowing competition while neither privatising nor killingo� the original state incumbents means big losses at some dyingpublic �rms. Air India and MTNL, a telecoms company, betweenthem lost almost $2 billion in the �scal year 2009-10. Of 217 in-dustrial enterprises owned by the central government in 2010, 59made losses (see chart 7). At the state-government level there areperhaps another 850-odd government-owned �rms, includingzombie local electricity distributors. Their losses would wipeout most of the pro�ts made by the listed giants.

Pro�t and loss is the least of it. India’s inexorably growingpower crisis is a bottleneck that threatens to hobble its overallgrowth rate. An orthodox Western remedy would be to let inBHP Billiton, an Australian mining colossus, to dig up India’s coalfaster, while selling o� the bankrupt electricity boards to private�rms, who have made dramatic improvements in the few placesin India where they have taken charge. But if the state is not pre-pared to let the private sector tackle its rotten parts, then it willneed to adopt a more strong-armed, Chinese-style approach tomaking sure the state sector delivers. The middle way it is cur-rently pursuing isn’t working�as those power cuts testify. 7

State-controlled �rms

The power and theglory

India has its own form of state-backed capitalism too

7In better nick than you’d think

Source: Department of Public Enterprises *Converted at exchange rate of 45 rupees per $

Profits/losses of companies controlled by the central government, $bn*

Fiscal years ending March

10

0

10

20

30

+

–

2001 02 03 04 05 06 07 08 09 10

Overall return on equity, %

We’re from the government, and we’re here to help

12 The Economist October 22nd 2011

BUSINESS IN INDIA

SPECIAL REPORT

1

SACHIN BANSAL AND Binny Bansal are not identicaltwins, or even related, but they should be. They both grew

up in Chandigarh in north-west India, studied computer engi-neering at the Indian Institute of Technology Delhi and spent abrief stint working for the same American technology �rm. Twoyears after meeting in Delhi in 2005 they took $10,000 of theirsavings, set up shop in a �at in Bangalore and began an e-com-merce business that delivered books to people’s homes�likeAmazon, but with an Indian twist.

Making the leap, says Binny Bansal, �wasn’t di�cult�. To-day the �rm they co-founded, Flipkart, is one of India’s hottestinternet businesses, selling everything from books to phones.The site clocks up sales of $10m a monthfrom over 1m registered users. Flipkart issaid to be negotiating a fourth round offunding from venture-capital �rms at anappropriately stonking valuation.

Such success stories should be whatIndia is all about. But there is a naggingworry that there are far more consultants,bankers, academics and journalists cele-brating India’s entrepreneurial zeal thanpeople actually starting new companies.Take the latest �gures from the Indian In-stitute of Management Ahmedabad(IIMA), India’s leading business school.Of the 314 graduates from its �agship pro-gramme, only seven started a business.An amazing 187 joined the gravy train andgot jobs in consulting or �nance�the kindof statistic common in rich countrieswhich is now taken as a symptom of theirdecline. One bigwig at a large Indian �rmsays he implores his younger relatives:�Make something. Don’t just look at num-bers and criticise things.� But he admitsdefeat. They are all becoming spread-sheet wizards at banks.

The sense that entrepreneurs havenot made the kind of mark they shouldhave in the past decade seems to be true across the Indian econ-omy. In a paper published by the IMF in January, three econo-mists, Ashoka Mody, Anusha Nath and Michael Walton, lookedat the Bombay Stock Exchange, a decent proxy for India’s formalbusiness sector, with thousands of �rms listed on it, many verysmall. They concluded that in the 1990s there was a surge of new�rms without a�liation to established family-controlledhouses, but that in the past decade the process of new entry �vir-tually stopped�. Similarly, the share of pro�ts from new, inde-pendent companies, having risen rapidly in the 1990s, has sincestagnated. Many business folk reckon that the relatively fewnewcomers that have made it big since 2000 are in old-economy�rent-seeking� sectors that require more brawn than innovation.

It’s not di�cult to rustle up some possible reasons for allthis. India scores abysmally in the World Bank’s global surveys

of how easy it is to start a new �rm. Given the propensity of es-tablished �rms to diversify into new areas, it seems likely thatstart-ups are sometimes crowded out. India’s banks are not hugefans of lending to small �rms; they often demand onerousamounts of collateral or security on �xed assets, exactly thekinds of things start-ups cannot provide. There is a decentenough venture-capital industry, but even so, new �rms face hur-dles that do not exist in other countries, which may require themto invest more heavily upfront. Flipkart is a good illustration ofthis�with a happy ending.

It began as a Western �rm might, as the middleman be-tween book wholesalers and its customers, using third-partycouriers to deliver to people’s homes nationwide. But Flipkartsoon overwhelmed the local wholesalers and courier �rms inBangalore. To cope, it has now built �ve warehouses nationwideand hired an army of delivery sta�. In India �you don’t have reli-able service providers like DHL,� says Binny Bansal. A round offund-raising in 2009 helped pay for these investments. By 2010another problem had to be addressed: not many Indians havecredit cards, and those that do worry about security. The sol-ution was to accept cash, or more recently credit cards, at thedoorstep. Meanwhile, Flipkart must also contend with the big

business groups, like Reliance Industries, which are interested inretail. The hope is that Flipkart’s heavy and early investment inits brand, including a big television campaign, will be enough ofa defence when the big boys move in.

To succeed in India, then, Flipkart, like most bigger �rms,has had to integrate vertically, taking on more processes itself,from storage to delivery and payments. That costs serious mon-ey. And from an early stage it has had to anticipate a competitivethreat from the big family giants. The upshot is that although In-dia’s e-commerce opportunity is huge, the barriers to small �rmsare quite big too, requiring more capital, earlier, than might oth-erwise be the case. In the dotcom industry such funds are at leastrelatively easy to obtain. Ashok Kurien, the former Thums Upmarketer, and since then a serial entrepreneur, is involved withseveral websites. One of them, called Bollywood Life, received

The outlook for entrepreneurs

Looking for the nextInfosys

India has aspiring entrepreneurs aplenty. More of

them need to make it

They don’t just sell�they deliver, too

The Economist October 22nd 2011 13

SPECIAL REPORTBUSINESS IN INDIA

2

1

IT’S NOT A movie set. Mumbai today really is a place whereyou can see Rolls-Royces bumping along pot-holed streets

past naked children, in the shadow of billionaires’ personal sky-scrapers. India’s capitalism is raw and sometimes ugly, but itsprivate-sector �rms are dynamic and mostly optimistic. If thecountry maintains its current rate of growth it is expected to be-come the world’s third-largest economy some time after 2030,and hundreds of millions of people will lift themselves out ofpoverty. But it is not a second China. Thanks to an exhausted andcranky state, for which there is no prospect of dramatic reform,much of the job of development will fall upon the private sector.India’s companies are refreshingly red-blooded, but more thanother �rms in the world they carry a giant responsibility.

This special report has argued that after a decade of eupho-ria the business scene has sobered up, partly prompted by asticky patch in the economy and the depression in the richworld. Over the past decade a new kind of capitalism has en-trenched itself in India, in which large family concerns, often intheir second generation or older, hold remarkable sway. Yet theprivate sector is not the comfortable oligarchy it might seem, forfamily �rms compete head on and often live and die by thesword. And although some big hereditary groups often seem toprefer investing abroad to investing in India, collectively these�rms are prepared to stump up very large amounts of money onlong-term capital projects in India�the kind of money that only

The Indian miracle and the future

Rolls-Royces andpot-holes

Long-term economic success may make the current

way of doing business obsolete

2m unique visitors within 90 days of launch. He has already had�ridiculous o�ers� from outside investors, he beams.

Outside the dotcom industry, though, raising money ismore of a slog. And there are big barriers to entry, just of a di�er-ent sort. Memories of how much e�ort it took to succeed arecommon the world over, but in India, it often seems that an extrapush was required. Haresh Chawla, the chief executive of Net-work 18, a broadcaster, says that when it launched its news chan-nels in 2004-05, in partnership with CNN and CNBC, it threweverything at it. �Consumers only give you one chance,� he says.

In 2008 his �rm launched Colors, a Hindi entertainment channelthat became top-rated within nine months of its launch. It spent$125m up front on programming and promotions rather than en-gage in a long war of attrition with the established channels.�You cannot tiptoe in India,� he says.

Just �ll in a few forms �rst, please

Banking may present start-ups with the most formidablehurdles of all, in the form of India’s �nancial regulators, and con-sumers’ preference for established lenders, particularly state-owned ones. Rana Kapoor, who in 2004 founded Yes Bank, nowone of the larger private players, jokes that getting a licence was a�Himalayan task�, taking over a year, while building the busi-ness was a �Herculean� one. �As part of our business culture, no-body helps the underdog,� he says. Yes Bank broke through, MrKapoor says, partly by focusing on squeaky-clean corporate go-vernance from day one, and listing the �rm as soon as possible togain attention and credibility.

And yet, for all these barriers, new �rms are emerging inunexpected places. Vinayak Chatterjee, who graduated fromIIMA in 1981, �rst joined a consumer-goods �rm. After decidingagainst a life-sentence of selling soap, he went on to establishFeedback Infra, an engineering and consulting �rm in Delhi thatspecialises in infrastructure projects. With 1,250-odd sta�, half ofthem engineers, and a list of blue-chip and government clients, itexempli�es the kind of high-end services that India could excelat. Mr Chatterjee reckons his costs are a quarter of rich-world�rms’. Big parts of this business are �no di�erent fundamentallyfrom IT outsourcing�, he says. The priority for now, though, is tobuild scale at home. With about $50m of revenue, growing byabout 30% a year, the �rm is on its way to that goal. A �otationwould be a natural next stage in a few years’ time.

Almost every investor and �nancial rag has a list of their fa-vourite entrepreneurs. The question for India is whether a fewimpressive examples here and there add up to a trend. The datafor the past decade look disappointing, suggesting that thingshave deteriorated since the 1990s. The hope is that this is a back-ward-looking signal about the dynamism of Indian capitalism.Vijay Angadi, a veteran of small-company investing in Indiawho runs Novastar, a $200m fund, is con�dent that a new gener-ation of �rms will come through eventually. He reckons that the�rst initial public o�ering of a venture-backed start-up in Indiatook place only in 2004. He is optimistic that the venture-capitalindustry has become more open-minded, and is no longer ob-sessed solely with technology �rms. Wealthy angel investors arebecoming more important, too. A decade ago, approached by anentrepreneur who was not in the family, �they would have

laughed him out.� Now, however, theymight write a cheque.

And when it comes to small �rms,India certainly has a lot of raw material.W. Sean Sovak of Lighthouse, a private-equity fund based in Mumbai that is fo-cused on small companies, reckons thereare some 2,000 �rms listed on Mumbai’sstock exchange that are active and havemarket values of below $200m. He �rstvisited India in 2004 and was �blownaway� by its vigour. He and his co-foun-der, Mukund Krishnaswami, an Ameri-can whose parents emigrated from India,both chucked in careers in America in-vesting in small �rms and headed toMumbai to set up Lighthouse in 2006. MrSovak cautions that all is not rosy; many

small �rms are in commoditised businesses, he says, and evenhigh-quality �rms �face lots of challenges� and may struggle tomanage their growth. But he too is optimistic. �We’ve seen someof the best entrepreneurs of our lives here,� he says.

Will they succeed? Mr Bansal of Flipkart reckons so. �Be-tween 2004 and 2009 there was not a lot coming out in terms ofentrepreneurs,� he says. But over time they will begin to chal-lenge the established business order. �In �ve to ten years youwill see a shift happening,� he predicts. It is vital for Indian capi-talism that he is proved right. 7

The question for India is whether a few impressiveentrepreneurs here and there add up to a trend. Thedata for the past decade look disappointing

rent way of doing things is long-term economic success. It wouldmake today’s approach to organis-ing �rms redundant. And there isanother danger that is rarely men-tioned in the o�ces of businessbigwigs.

Don’t just adapt. Lead

As the corporate scene hasfound its own rhythm in the pastdecade, something has been lost:the idea that the company doesnot merely adapt to the society itoperates in, but also acts to driveup standards, even if the state can-not. The original stars of India’smiracle, �rms like Infosys, werelike breaths of fresh air, with top-notch governance. Today’s bossesseem world-wearier, while o�-cials in some cases have been cap-tured by vested interests and havelost enthusiasm for pushingthrough world-class standards insimple but vital areas like account-ing. In the past year of corruptionscandals, too many Indian busi-nesses have been cowardly, likewitnesses so terri�ed of being im-plicated that they do not de-nounce a crime. The job of prodding the government into actionagainst graft, and of raising standards, has therefore been left tobig street protests of urban middle-class people who are fed up.

The second danger for India’s business establishment isstraightforward: hope. Especially in the cities, aspirations havebeen raised. That powerful and inspiring optimism is the under-lying engine of India’s miracle, but it is politically essential thatpeople’s expectations be met. In the next decade many more en-trepreneurs must break through the established business order.Opportunities must be seen to grow as fast as pro�ts. Otherwise,at some point, the giant crowds of frustrated urbanites mightturn their attention from India’s government to its billionaires. 7

14 The Economist October 22nd 2011

BUSINESS IN INDIA

SPECIAL REPORT

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the government in China, orbond markets in the West, canconjure up.

Many of the big cross-border takeovers of the pastseven years, by Indian �rmsabroad and foreign �rms intothe subcontinent, are not thetriumphs their promoters andexcited supporters claim. Oneor two almost sank their back-ers and some will never makea decent return on capital. Thisyardstick tends to be shruggedo� by empire builders, but inthe long run it is the only onethat counts. Indian businesses

are going global quicker, earlier and more deeply than perhapsany other country’s have�but the more durable trend is in themyriad of smaller expansions below the surface, not the trophytransactions bankers brag of.

At the same time, companies have discovered the limits offrugality: cutting prices and building big customer bases maysometimes lose them money, rather than making it. Big state-owned companies dominate in sectors politicians judge to bestrategic. The areas where the government still runs the show areoften plagued with problems. And despite all the hype aboutnew entrepreneurs, they have had a mediocre decade.

Some Indians feel that Western critics of their approach arehypocritical�after all, didn’t America also have a stage whenfamilies dominated the business scene? They have a point. Butthe idea that India is merely at an earlier evolutionary stage onan American journey looks misplaced. India’s soft state encour-ages the conglomerate form of doing business, whether ownedby a bloodline or not. This corporate model does not contain the�nancial seeds of its own destruction�not immediately, any-way. Over time the problems of succession and attracting out-side capital will eventually cause families to cede control. But nosudden change is likely.

The triumph of the conglomerate in India, often family-controlled, does contain a contradiction, however. Today’s wayof doing things re�ects a rational and even admirable capitalistresponse to the shortcomings of the state, and has helped India’seconomy motor along despite them. But at some point the mud-dle-through approach may yield dimin-ishing returns. The recent wobble in theeconomy and dip in investment by theprivate sector has come after a long per-iod of government inertia and scandal. Ithas prompted some to doubt whether thecountry can really deliver growth of 8% ormore without sparking in�ation.

If India is to �nish the long journeyto superpower status that has been plot-ted for it by many forecasters, it will haveto get its act together on things like infra-structure, e�cient land allocation, educa-tion, bond markets, reliable supply chainsand the enforcement of contracts. Yet if itmanages to make progress in these areas,the rationale for sprawling big businessgroups�sometimes almost like mini-states in their own right, as substitutes forthe real thing�will gradually disappear. Abig danger, then, to Indian business’s cur- A tale of two cities

02 04 06 08 10

8Abundant

Source: Forbes

Number of Indian billionaires

0

10

20

30

40

50

60

2001 03 05 07 09 11

2