FDI strategy for Indian firms
Business Standard, 25 November 2024
All important global firms are multinationals. Many large Indian firms have initiated overseas FDI activities. As yet, this is a field where the playbook and the capabilities are at an early stage.
Watching global firms utilising services production in India offers insights in the role of FDI. Global firms have played all possible pathways to meet their objective of harnessing the Indian workforce. They send work through arms-length contracting to Indian services firms. They do FDI into captives and GCCs. They use GCCs in India as a platform for negotiation and supervision of contracting-out to Indian services firms. Harnessing globalisation requires such a sophisticated mix of contracts and FDI.
Why might Indian firms benefit from doing FDI? Successful FDI initiatives help:
- Enhance exports,
- Permit global optimisation of operations including improved domestic competitiveness,
- Give access to the vast world market, and
- Derisk the firm in slow periods in the Indian economy.
A unique feature of the Indian environment, which is not found in global firms, is the gains obtained by reducing engagement with Indian taxation and capital controls. This is a sweetener which helps pay for the fixed costs of graduating to FDI.
It is useful to establish a 2x2 classification scheme. Indian firms come in two kinds: Those that do things which are readily sold to global customers (e.g. ball bearings) vs. those that that are wedded into the Indian landscape (firms with operational capabilities that are rooted in the Indian policy environment, which are deeply connected to the quirks of the Indian landscape). And destination countries come in two kinds: advanced economies and the rest.
Low engagement with the Indian state High engagement with the Indian state FDI into advanced economies FDI into EMs/LDCs In the field of international trade, the traditional classification has been that between tradeables (things like ball bearings) vs. non-tradeables (things like haircuts). But once FDI is in play, it is perfectly possible for an Indian firm to deliver haircuts to a customer in New York by doing FDI. Hence, the distinction between tradeables and non-tradeables is no longer that useful. The useful distinctions are between firms in India who have low vs. high engagement with the Indian state, and their going into high rule of law environments vs. other countries.
Indian firms operating in relative freedom
The simplest pathway to globalisation is available for firms which are not significantly influenced by the Indian state. For these firms, the journey of exporting and FDI holds unlimited potential in terms of expanding the business. They can aspire to become global firms which are particularly good at placing certain functions into India where lower costs are feasible. The emergence of these capabilities in the world of Indian business is of great importance for India's economic future [EiE Ep48]. If 100 Indian firms graduate into becoming big multinationals -- e.g. a balance sheet size of over Rs.10 trillion with over 50% of revenues from markets outside India -- this will transform Indian GDP.
For these firms, the management methods and the organisational culture that flourishes in India can run into difficulties when faced with the rule of law. Operating in advanced economies comes with the need to run a tight ship. Non-OECD countries can also be markets, but this market size is small when compared with the advanced economies.
The India-centric management DNA might be particularly effective in operating in non-OECD countries. There are two difficulties here. To paraphrase Tolstoy, all advanced economies are alike, but each poor country is poor in its own way. And, the leadership needs to be wary of quick wins outside of the advanced economies, as their main game is learning to operate and sell into the advanced economies. Arms length contracting into local firms is a good way to harness the market potential of non-OECD countries without fully learning their unique institutional arrangements and lack of rule of law.
Indian firms with more engagement with the Indian state
Things are a bit more difficult for Indian firms who are more wedded into the Indian landscape. They are in industries which require a high government interface (e.g. with regulators), in industries where the Indian state runs a central planning system, they may utilise quirks of operating in the Indian environment (e.g. connecting into PSU monopolies [EiE Ep56]]) or they may be in areas where the Indian state is an important customer. For all these firms, their very strength in India -- learning to function and flourish in close proximity to the Indian state -- is a hindrance when it comes to succeeding abroad. For example, a successful bank in India that has mastered profitability while operating under RBI's central planning system, protected from foreign competition, and plugging into a variety of PSU monopolies, is not ready to succeed in (say) the US in competition against US rivals that have not been similarly distorted. The unique edge of an Indian bank would be in efficient production in India, but its local rivals in the US are increasingly effective in harnessing low cost production in India through GCCs.
When these firms operate in OECD countries, there is the risk that their organisational culture which is shaped by experiences of engaging with the Indian state may raise eyebrows or break rules in OECD countries. They would need a self-conscious effort to operate in OECD countries with a business culture that avoids the ways of the HQ.
For these firms, operating in non-OECD countries, with more limited rule of law, is more analogous to operating in India. But building the relationships to operate in a sustained way, across fluctuations of the political system, is also difficult when compared with the long years of experience and relationships that are in place in India. Hence, for these firms also, the optimal strategy for operating in a non-OECD country may be to rely on a partnership model. This is analogous to the way some global firms choose to partner in India, instead of going it alone, seeking political risk management through a well entrenched Indian partner.
The questions for strategy
Shareholders, board members and senior managers need to think strategically about these questions. Large gains are available from FDI, but this requires strategic thinking. The 2x2 diagram shown here helps organise the range of possibilities and shapes the development of the requisite capabilities in each project of firm internationalisation. Many interesting choices can be made, e.g. perhaps a private Indian defence manufacturer can step out of the category `Industries with more connections to the Indian state' by ceasing sales to the Indian state. Portfolio strategists can also utilise these themes, with an emphasis on the best Indian firms which are readily able to grow through exports and FDI into OECD countries.
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