India Inc. needs a new framework for growth

Deepak Sharma        Last Updated: October 5, 2016  | 12:49 IST
India Inc. needs a new framework for growth

India's largest companies have suffered from declining profitability over the past five years as they struggled to adapt to a 'new normal' of greater volatility and uncertainty, rising debts and the growing impact of digital disruption. As a consequence, business leaders are in search of a new framework with which to strategise for growth in today's changed world.

While in 2016 India might be lauded as the world's fastest growing large economy, its top corporations have not been able to emulate this performance. A multi-year study we conducted of India's top 1,000 companies found that from 2010 to 2015, EBITDA as a percentage of GDP at India Inc. fell from 8.7 per cent to 7.2 per cent, while net profit tumbled from 4.1 per cent to only 2 per cent.

Just as interestingly, the fortunes of different industries have taken divergent paths over this period. Today a mere five sectors capture almost 75 per cent of India's total corporate profits, up from 39 per cent in 2010. The stand-out winners have been the automotive, auto-components, healthcare, IT and utilities sectors, all of which have increased their share of the profit pie. By contrast, the big losers have been construction, metals & mining, and capital goods, which have all swung to sector level losses.

Many of these gains and falls can be explained by industry-specific developments. However, deeper analysis reveals that such sector-wide trends are a poor indicator of individual company performance. Our analysis has found that the most important factor in a company's profitability is its growth rate. Those companies that managed to grow aggressively (i.e. at higher than their industry's median growth rate) were able to increase profitability over the last five years. While those that grew below the median rate were more likely to see a decline in profits.

Furthermore, despite the challenges faced by particular industries, there are companies in every sector in India that have achieved breakthrough revenue growth. In fact, there is eight times more variation in revenue growth inside sectors than between sectors. Therefore, growth is not only the key to greater profits but it is possible for every Indian company regardless of the business they operate in.

Growth, then, is clearly possible. However, the journey today is more challenging than ever before for three important reasons:

First, volatility and uncertainty have become the 'new normal' as India gets increasingly integrated into the global economy and more exposed to its convulsions. Whether through shocks in global demand, sharp commodity price movements or exchange rate fluctuations, India has experienced unprecedented macroeconomic volatility in recent years.

The second challenge to India Inc.'s growth is the rapid rise of digital disruption. While India lagged behind during the first dotcom boom of the 1990s, today it is a leader in digital innovation with the third largest number of start-ups globally. In 2015 alone, over $9 billion was invested in the Indian technology sector, around 50 per cent of the total investment received in all previous years. While the valuation of tech companies may rise and fall, the shift to digital is profound and enduring and it has major implications for every business.

There are several reasons why the digital shift is so important. First, digital players are uniquely able to insert themselves between suppliers and customers to capture the relationship. In turn, this position gives them access to vast amounts of data, which today can be leveraged through advanced analytics. Further, digital players' emphasis on platform allows them to rapidly aggregate unorganised players to achieve huge scale. This is a capability Uber and Ola have demonstrated highly effectively in the Indian market. In addition, digital disruptors' lack of legacy costs allows them to quickly adopt new technologies and business models, while their asset-light approach allows them to scale at lower cost.

The third challenge to growth at India Inc. is the indebtedness of many corporations. We have found that almost one-third of India's top companies are caught in the debt trap and that number is still rising. The debt trap has eroded profitability at India Inc. and undermined its capacity to invest. This is a major obstacle to growth at a time when companies need buffers to withstand shocks from a volatile external environment and surpluses to invest in new technologies that are re-shaping their industries.

Given the challenging environment India Inc. finds itself in, the growth strategies pursued in the past will be inadequate for the journey ahead. Therefore, we believe CEOs need a new framework to think about growth in today's changed world. From extensive research into the growth issue we have distilled this down to four fundamentals of success, which we call the 'ROAD' framework.

The 'ROAD' framework is based on the need for India's business leaders to Reset their assumptions, Organise for the future, advance with Agility and Digitalise their business.

To begin with, CEOs must reset their assumptions about the macro environment, the growth outlook, their industry's boundaries, and the competitive threats they face. This is because any strategy a company makes will be based on all of these assumptions and the profound changes of recent years have rendered many of them redundant. If this reset were to be applied to the automotive industry, for example, incumbents like Maruti Suzuki or Mahindra may need to reframe their market boundaries to include the likes of Google or Apple as the development of driverless technologies continues to accelerate.

The second part of the ROAD framework is organising for the future. This is a particularly pertinent challenge for CEOs in India as they will need to lead a transition from traditional hierarchies to more fluid structures that can adapt to change must faster. This transition is even more critical because India has more millennials of working age than any other country in the world, with 209 million people in the 24-35 age bracket. This generation has very different expectations of the workplace and companies will need to change to attract, retain and motivate them.

The third element to India Inc.'s future growth framework is agility. This is an organisation's ability to quickly sense, interpret, act and adapt to today's constantly changing external environment. Leaders need to be continually tuned into the external environment to sense emerging threats as early as possible. They also need the mental flexibility to objectively consider new information that may challenge their existing world view. Further, they must have a bias for action to overcome the tendency toward inertia in any large organisation. The TATA Group has appreciated this necessity with CEO Cyrus Mistry stressing the need for 'strategic and organisational agility' and a 'sense of urgency' in its Vision 2025 document.

The fourth and final element of the growth framework is the need for India Inc. to digitalise. As digital disruption spreads from the low-hanging fruit of media and retail, its potential to transform every industry is now becoming clear. Industrial giant GE has pioneered the digitalisation shift by positioning itself as "The digital company. That's also an industrial company". In doing so, it has created a 'Platform as a Service' model to capture and analyse the vast quantities of industrial data that now flow from connected machines - ranging from aircraft engines to washing machines.

To truly understand the importance of the shift that is occurring, we need to place it in an historical perspective. In the 19th Century, control of physical resources was critical to most companies' business models. In the 20th Century, brands and patents emerged as key profit drivers. However, in the 21st Century, data is fast becoming companies' most valuable asset.

As India's corporate leaders get to work on their future growth strategies, it is becoming increasingly clear that they will need a new framework to achieve improved performance in today's radically changed world.

The writer is Director of Strategy at Kanvic Consulting

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